The Bottom Line:
- UK CPI has dropped to 2%, the first developed economy to hit this target
- Core inflation remains at 3.5%, with price pressures in certain areas of the economy
- The Bank of England is unlikely to cut rates immediately, despite the CPI data
- Focus of the upcoming meeting will be on forward guidance and vote splits
- Markets are pricing in a potential rate cut between September and November
UK Becomes First Developed Economy to Reach 2% Inflation Goal
Core Inflation Remains Elevated at 3.5%
While the headline inflation figure has dropped to the Bank of England’s target of 2%, a deeper look into the data reveals that core inflation, which excludes volatile energy prices, remains elevated at 3.5% for the 12 months to May. This suggests that there are still pockets of inflationary pressure within the economy, particularly in the services sector, where wage pressures have been persistent.
Wage Growth Continues to Add Inflationary Pressure
Prior to the release of the inflation data, the UK labor market report showed that wages continue to increase, both including and excluding bonuses. This wage growth adds inflationary pressure to the economy and is a key area of concern for the Bank of England. Despite the headline inflation figure reaching the 2% target, the central bank may be hesitant to cut rates immediately due to these underlying wage pressures.
Disinflation Process Underway, but Deflationary Environment Not Yet Achieved
It is important to note that while the UK has reached the 2% inflation target, the economy is not yet in a deflationary environment. Instead, it is experiencing a disinflation process, where the rate of inflation is slowing down, but prices are not actually decreasing month-over-month. After two years of high inflation, simply reaching the 2% target is not enough to prompt immediate action from the Bank of England, and markets recognize this fact, as evidenced by the muted reaction to the inflation data release.
Core Inflation Remains Elevated at 3.5% Amid Persistent Price Pressures
Persistent Price Pressures in Core Inflation
While the headline CPI figure has reached the Bank of England’s 2% target, core inflation, which excludes volatile energy prices, remains elevated at 3.5% for the 12 months to May. This indicates that there are still areas within the economy where price pressures persist, particularly in the services sector. The monthly core inflation figure for May came in at 0.5%, down from 0.8% in April, showing a significant slowing in the rate of price increases. However, these pockets of inflation prevent the Bank of England from immediately considering rate cuts.
Wage Growth Continues to Fuel Inflationary Concerns
The UK labor market data released last week showed that wages continue to rise, both including and excluding bonuses. This wage growth adds inflationary pressure to the economy and is a key focal point for the Bank of England. The central bank will likely remain cautious in its approach to monetary policy, as these wage pressures could hinder the progress made in bringing down overall inflation. The services sector, in particular, has been stubborn in terms of price pressures, and this is where a significant portion of the wage pressures are being observed.
Disinflation Process Underway, but Deflationary Environment Not Yet Reached
Although the UK has achieved the 2% inflation target, it is essential to recognize that the economy is not in a deflationary environment. Instead, it is experiencing a disinflation process, where the rate of inflation is slowing down, but prices are not decreasing on a month-to-month basis. Following two years of high inflation, simply reaching the 2% target is not sufficient for the Bank of England to start cutting rates immediately. Markets acknowledge this fact, which explains the relatively muted reaction to the inflation data release. The Bank of England will likely maintain a cautious stance, monitoring the progress of core inflation and wage growth before making any significant changes to its monetary policy.
BoE Expected to Maintain Interest Rates in Upcoming Meeting
No Immediate Rate Cuts Expected
Despite the UK’s success in bringing headline inflation down to the 2% target, the Bank of England is unlikely to announce any immediate rate cuts during its upcoming meeting on Thursday. The market has priced in a 90% probability that the central bank will maintain interest rates at their current level. The focus will be on the messaging from Governor Andrew Bailey and his team, as they have been relatively quiet in recent weeks due to the blackout period surrounding the snap election announced by Prime Minister Rishi Sunak.
Forward Guidance and Vote Split in Focus
Market participants will be closely watching the Bank of England’s forward guidance and any indications of potential rate cuts in the near future. However, given the central bank’s tendency to hold its cards close to its chest, it seems unlikely that they will provide any clear signals at this meeting. The vote split among the Monetary Policy Committee (MPC) members will also be a point of interest. In the May meeting, two members voted for an immediate rate cut, with one of them being the typically dovish Silvana Tenreyro, while the other, Dave Ramsden, surprised the market with his vote. If the vote split changes, either with another member voting for a 25 basis point cut or with Ramsden reversing his previous vote, it could have implications for market sentiment.
Timing of Potential Rate Cuts
As the Bank of England assesses the latest inflation data and considers the underlying price pressures, particularly in the services sector and wage growth, markets are pricing in the possibility of a rate cut between September and November. The chances of a rate cut in August currently stand at around 30%. These expectations could shift following the outcome of the Bank of England meeting on Thursday, depending on the tone of the messaging from Governor Bailey, the vote split among MPC members, and their comments regarding the return of inflation to the target level. While the UK has made significant progress in its fight against inflation, the central bank is likely to remain cautious in its approach to monetary policy, ensuring that the economy is on a sustainable path towards price stability.
Forward Guidance and Vote Splits to be Key Focus of BoE Meeting
Market Reaction to Depend on Forward Guidance and Vote Split
The market reaction to the Bank of England’s decision will largely depend on the forward guidance provided by Governor Andrew Bailey and his team, as well as the vote split among the Monetary Policy Committee (MPC) members. If the messaging remains unchanged and the vote split stays at 7-2, with Silvana Tenreyro and Dave Ramsden voting for a rate cut, the market impact may be limited. However, if the vote split shifts to 6-3, with another member joining the call for a 25 basis point cut, or if Ramsden reverses his previous vote, resulting in an 8-1 split, it could signal a more dovish stance and potentially affect market sentiment.
Timing of Rate Cuts Remains Uncertain
While the UK has successfully brought headline inflation down to the 2% target, the Bank of England is unlikely to rush into rate cuts. Markets are currently pricing in the possibility of a rate cut between September and November, with the chances of a cut in August standing at around 30%. The exact timing of any rate cuts will depend on the Bank of England’s assessment of the underlying inflationary pressures, particularly in the services sector and wage growth. The central bank will likely remain cautious in its approach, aiming to ensure that the economy is on a sustainable path towards price stability before making any significant changes to its monetary policy.
Pound Sterling and FTSE Reaction to Inflation Data and BoE Meeting
Following the release of the inflation data, the pound sterling (GBP) has shown positive momentum against the US dollar (USD), continuing the reversal that began earlier in the week. Despite the lower inflation figure typically being bearish for the pound due to rate differentials, the fact that the data came in line with expectations and the UK economy’s relative underperformance compared to the US has allowed markets to react positively. The immediate resistance level for GBP/USD appears to be the 20-day simple moving average, currently at 1.2742. A break above this level could see buyers target the ascending trendline starting from April 22nd.
The FTSE 100 index has experienced some weakness in recent days, in line with the broader European equity market sentiment. Political uncertainty in France and the upcoming UK general election have added a layer of risk, which has been priced into the market. However, the sell-off in the FTSE has been less pronounced compared to other European indices.
Markets Anticipate Potential Rate Cut Between September and November
Markets Anticipate Potential Rate Cut Between September and November
Despite the UK’s success in bringing headline inflation down to the 2% target, the Bank of England is unlikely to announce any immediate rate cuts during its upcoming meeting on Thursday. The market has priced in a 90% probability that the central bank will maintain interest rates at their current level. However, looking ahead, markets are anticipating a potential rate cut between September and November, with the chances of a cut in August currently standing at around 30%.
Forward Guidance and Vote Split to Provide Insight into Future Policy Moves
The focus of the upcoming Bank of England meeting will be on the forward guidance provided by Governor Andrew Bailey and his team, as well as the vote split among the Monetary Policy Committee (MPC) members. While the central bank has been relatively quiet in recent weeks due to the blackout period surrounding the snap election announced by Prime Minister Rishi Sunak, market participants will be closely watching for any indications of potential rate cuts in the near future. The vote split among MPC members will also be a point of interest, as changes in the voting pattern could signal shifts in the committee’s stance on monetary policy.
Pound Sterling and FTSE React to Inflation Data and Anticipated BoE Decision
Following the release of the inflation data, the pound sterling (GBP) has shown positive momentum against the US dollar (USD), continuing the reversal that began earlier in the week. The fact that the data came in line with expectations and the UK economy’s relative underperformance compared to the US has allowed markets to react positively. The FTSE 100 index, however, has experienced some weakness in recent days, in line with the broader European equity market sentiment, as political uncertainty in France and the upcoming UK general election have added a layer of risk to the market.
