May’s inflation data was stronger-than-expected today. The headline consumer price index (CPI) rose by 0.6%MoM pushing up YoY inflation from 1.5% to 2.1%, above the Bank of England’s (BoE) 2% target as the first chart shows. Excluding food and energy costs, core CPI inflation also increased sharply from 1.3% to 2.0% last month.
Source: Bank of Singapore, Bloomberg
The BoE expects inflation will rise temporarily above target this year as the economy reopens and demand outstrips supply. The central bank forecasts inflation will peak around 2.5% in 2021. Thus, today’s CPI report is unlikely to make the BoE alarmed. In addition, May’s jump in headline and core inflation was driven by typically volatile items including energy, clothing, footwear and recreational goods like video games.
Source: Bank of Singapore, Bloomberg
But May’s inflation data combined with April’s employment report released yesterday support the BoE’s earlier decision to become the first major central bank to start tapering its quantitative easing this year. As the first chart shows, the unemployment rate continues to dip to 4.7% now as the UK economy reopens. The labour market data remains flattered by the government’s pandemic Jobs Retention Scheme. But even when the wage subsidy ends in September and unemployment likely rises, the peak in the UK jobless rate will be far lower than the 8% rates seen after the 2008 financial crisis.
This week the government was forced to delay lifting its last lockdown restrictions for another four weeks by new virus cases spread by the delta variant. But with April’s GDP increasing by 2.3% in just one month, the UK economy is already recovering quickly from the pandemic.
Though unemployment is likely to make inflation overshoots above the BoE’s 2% target prove to be only temporary this year, we think the BoE is on track to be the first major central bank to finish its quantitative easing altogether by the end of this year and to start raising interest rates next year. Inflation is likely to fall back but stay around the BoE’s 2% target in 2022 and unemployment may return to pre-pandemic levels closer to 4.0%. We thus expect the BoE to start lifting its Bank Rate from 0.10% from as early as next summer to the benefit of the GBP. The currency remains on a long-term uptrend as the second chart shows.
