Core UK Inflation Shock Shows the BoE’s Job is Not Yet Done

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Eurozone Market Update

In May, the ECB raised its three key rates by 25 bps, taking the deposit rate to 3.25%, in line with our expectations and those of the market. This ended the jumbo hikes we had seen since the end of 2022. The ECB's statement was more balanced, maintaining the ”data dependency” language for future decisions. However, it added focus on the transmission of policy, noting ”lags and strength of transmission to the real economy remain uncertain.” Speaking about the previous month’s banking turmoil, ECB President Christine Lagarde stated that European banks still looked resilient but struck a hawkish tone by noting that the ECB had more ground to cover, given the upside risk to inflation.

Euro Short Term Rates

_{Source: Bloomberg, data as at 31 May 2023}

UK Market Update

As widely forecasted, the BoE again increased its policy rate by 25 bps to 4.50% in May. The vote split remained unchanged from March at 7-2. Gross domestic product forecasts were revised higher, and there was an indication that any spillover from global banking sector turmoil would have little impact on the UK economy. The main shock came from inflation — while annual headline inflation in April dropped to 8.7% from 10.1%, this was well above market and BoE expectations. More significantly, annual core inflation accelerated to 6.8%, a 31-year high and notably higher than March’s 6.2% reading (see Chart of the Month). Swiftly after the shock, the markets immediately priced in a 25 bps hike for June, with some talk of the terminal UK rate priced in at 5.5% by Q4 2023.

GBP Short Term Rates

_{Source: Bloomberg, data as at 31 May 2023}

US Market Update

After much political tension and some worries over a potential US government default, Congress approved a suspension of the debt ceiling to January 2025 and President Joe Biden signed it into law. Earlier in May, the Federal Open Market Committee raised its target range for the federal funds rate by 25 bps. The policy statement removed language indicating that additional tightening “may be appropriate.” Instead, the committee noted that “…determining the extent to which additional policy firming may be appropriate…” will be highly data-dependent. Chair Jerome Powell reiterated the committee’s view that inflation would come down, but not as quickly as they would like to see, and that rate cuts would not be appropriate if the committee’s view of the inflation outlook proves accurate.

USD Short Term Rates

_{Source: Bloomberg, data as at 31 May 2023}

Looking Ahead

After making 25 bps hikes in May, the Fed, ECB and BoE return for further monetary policy meetings in June. Inflationary pressures remain elevated across all three markets, with core prices remaining sticky. This continues to create a problematic environment for central banks to take their foot off the pedal for now. These pressures are more pronounced in the UK with the strong UK inflation. Governor Andrew Bailey emphasised the evidence will guide decision-making, so we will continue to pay particular attention to the incoming data across all three markets to determine the future path of policy rates. We remain committed to our view that market expectations of policy easing are premature as core price pressures will keep central bank policy rates elevated for an extended period.

Chart of the Month: UK core inflation spike highlights the challenge still facing BoE

_{Source: Bloomberg, data as at 31 May 2023}

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