Rate cut bets hit as UK CPI rises more than expected

When the Bank of England cut rates earlier this month, it was already expressing its concerns about the outlook for the UK economy. The central bank cited increasing economic uncertainty ahead of another Autumn Budget that many expect could impose further tax rises on hard pressed consumers, as well as business.

This morning’s inflation numbers, which came in higher at 3.8% for July, weren’t completely unexpected given that the Bank of England expects CPI to peak at 4% in September, but they are still worrying so far that core CPI also rose sharply to 3.8% and was well above forecasts.  

More worryingly, food inflation also came in higher, surging from 4.5% in June to 4.9%, and while some of that increase isn’t entirely of the governments making due to seasonal issues, business isn’t being helped by higher costs of energy, production and labour costs.

Transport also saw a sizable rise due to higher airfares with fares rising sharply ahead of the school holidays, along with higher fuel costs.

Against this sort of backdrop, and with service sector inflation also rising faster than expected to 5% again, it’s hard to make the case that the Bank of England should be cutting rates at all.

In fact, it makes the idea that one policymaker wanted to cut rates by 50bps at the last meeting quite astonishing. Taxi for Alan Taylor?

Of course, the Bank of England isn’t being helped by officials at the Office for National Statistics (ONS) who seem completely unable to do the one job their title suggests it ought to be good at.

Since Labour took up the reins of government in July last year, inflation has gone from 2.2%, slowing briefly to 1.7% in September, before surging to where it is now at 3.8% now, yet in that time the Bank of England has cut rates 5 time in increments of 25bps, putting the base rate at 4%.

When looked at through that lens it’s surprising that we’ve seen 4 rate cuts since the inflation low point of 1.7%, while all the time hearing very little criticism of the central bank, which has as its sole mandate, a 2% inflation target.

At the same time Chairman Jay Powell of the Federal Reserve is getting bucketloads of opprobrium thrown his way because the FOMC hasn’t cut rates at all this year, with US inflation more or less unchanged from where it was a year ago, while inflation in Europe is also more contained.

In some ways one can sympathise with UK policymakers with plenty of discussion amongst MPC members about the correct action to take on rates at a time when the quality of that data from the ONS has been so unreliable.

That said it’s still notable that inflation here in the UK is well ahead of all its counterparts begging the question as to why that would be?

In the past 12 months there have been concerns raised about the quality of the unemployment numbers, trade data, as well as PPI, along with the cock-up over vehicle excise duty in the April CPI numbers.

The problems with the PPI numbers are a particular concern given how useful they can be in identifying CPI trends further down the line, while this week the ONS had to suspend the UK retail sales release for July due to concerns over data quality.

While a sensible measure to suspend the release on their part if there are concerns about the data, the fact that we’re talking about yet another data issue does beg the question as to how any of the data the ONS produces can be taken at face value.

With the Chancellor of the Exchequer’s so called fiscal headroom more or less already gone and the economy slowing, the idea that the government have taken the necessary steps to stabilise the public finances is gas-lighting of the highest order from a governing party that is trapped by its own contradictions, and couldn’t strategize its way out of a paper bag.   

We’re already hearing chatter that the government will have to raise taxes further to plug another fiscal hole that might exceed £20bn. What planet are these people on?

This is exactly the same argument we were hearing 12 months ago, and yet we are with a higher tax burden and still with the same, if not a bigger problem, while inflation is surging at a rate of knots, in contrast to our peers where it seems to be less of an issue.

The bond markets are already giving their verdict, with gilt yields higher than they were a year ago and with 125bps of rate cuts in the rear-view mirror from the Bank of England.

While shorter dated yields have remained relatively stable with the 2-year yield just below 4% and the 5-year just above 4%, more or less the same level they were a year ago, it is on the longer end that government finances are getting squeezed hard.

The public finances are already feeling the strain from higher interest payments, and when you look at the 30-year gilt yield it’s not hard to see why. In October last year yields were below 5%, rising to a 30 year high of 5.6% earlier this month.

Even the 10-year gilt yield is edging higher again, although not quite back at the pre financial crisis 2008 levels we saw at the start of the year, when it briefly nudged 4.90%.

This ought to be a red flag to anyone with a semblance of an understanding of how markets view the fiscal stewardship of an economy, yet the warning signs appear to be being ignored by those holding the purse strings in government.

Against this sort of backdrop, it won’t matter what the Bank of England does with the base rate when it meets next, whether that be in September, or November for that matter.

With UK inflation continuing to remain sticky, and rising faster than its international peers, the MPC’s room for manoeuvre is likely to get smaller, which means they may not be able to cut rates much further if inflation stays at or close to current levels.

The government could help of course by cutting spending, or spending the money it does more effectively, however history suggests that is unlikely to happen, at least not with this administration.

The private sector is unlikely to come to the rescue either, given that services inflation is running at 5%, while according to the Centre for Policy Studies it is now £2,367 more expensive to hire a worker on the minimum wage than it was in 2024.

All the while the recent S&P Global PMI employment survey showed that jobs declined for the 10^th month in a row, the longest spell of falls since the 2008-2009 financial crisis, with the PMI in July signalling the loss of 50k private sector jobs alone. The key driver on the PMI survey was rising costs as a result of last year’s budget.

Against such an economic backdrop, and with inflation still on an upward track, it is hard to make the case for further rate cuts at this time.

We’ve already seen the central bank cut rates 3 times this year, and in that time, CPI has gone from 3% in January, and could exceed 4% in September.

With another budget due in October, it would be a brave central bank that cuts rates further, especially since any recent cuts will take time to feed through, which means you run the risk that inflation becomes even more anchored than it is already.