Consumer prices in the UK rose much more sharply than expected in June – what are the implications for the Bank of England?
The sharper-than-expected rise in UK inflation to 1.9pc in June has sent the pound up against the dollar in anticipation that the Bank of England could be forced into an early rate rise. But are these worries justified?
What did the figures say?
Inflation, or the rise in the cost of consumer goods, climbed to 1.9pc in June, according to the Office for National Statistics. By contrast economists had, on average, predicted that inflation would edge up slightly to 1.6pc in June.
Why were economists so far off the mark?
The big surprise in last month’s inflation figures was that the price of clothes and shoes did not fall, as they usually do in June with the onset of summer sales. This is thought to be because the warm weather has kept the sales of summer fashion lines in demand and taken the pressure off the shops to start discounting.
What does this mean for the Bank of England?
The UK is currently in an economic sweet spot where the economy is growing but inflation has remained weak. This has allowed the Bank to maintain interest rates at their rock bottom levels, stimulating spending and further supporting economic growth: a virtuous circle.
But the economic thinking goes that this situation is unsustainable because growth will hit a tipping point where it will start to drive stronger wage growth, boosting demand and causing prices to rise too fast.
The trick for the Bank is to predict when this tipping point will occur. Then it can raise rates to curb spending and encourage saving, in the hope of keeping inflation near its 2pc target. At the moment, the Bank is expecting to start raising rates late this year or in early 2015.
So on the surface a sudden jump in the inflation rate to near the Bank’s target level should raise alarm bells, suggesting they got their sums wrong and need to rethink the timing of a rate rise.
But considering that the main driver behind the higher-than-expected inflation was probably a one-off effect that could be reversed next month, the Bank is unlikely to get its knickers in a twist.
It is partly due to the level of month-to-month “noise” in the inflation figures that the Bank of England’s own forecasts focus on the quarterly average, and as Sam Hill at RBS Capital Markets points out, June’s figures confirm the Bank’s prediction that inflation would average 1.7pc in the second quarter of the year.
Samuel Tombs at Capital Economics believes inflation will ease again by the end of the year and remain below the 2pc target in 2015, giving the Bank plenty of breathing space.
This will come as a relief to the Bank since there are still doubts over whether the economy is strong enough to withstand a rate rise. Recent data showed that growth in industrial production and construction slowed in May, suggesting that the recovery is still fragile.