UK inflation is at forty-year high

GBP

CPI in the UK rose by 9% in April year-on-year, a fresh forty-year high and yet another worrying print for the Bank of England. While the figure has provoked many tabloid headlines, financial markets had expected a slightly higher reading of 9.1% today, leaving Sterling relatively unchanged to lower post-release.

With CPI expected to climb to double digits during the second quarter, and rising wages threatening to make the situation worse, the central bank will likely become more hawkish over the coming weeks. The situation is such that the BoE will have to pull back accommodation more aggressively despite rapidly slowing growth.

The likelihood of a recession has increased in the last month despite the UK labour market being still in a good place. Policymakers, who now face a credibility problem, may soon recognise that it is better to go hard now on the tightening cycle to restore price stability than to risk a long term stagflationary slump that could be far more damaging to the economy.

EUR

Dutch central banker Klaas Knot yesterday became the first European Central Bank council member to float the idea of a 50 basis points interest rate hike in the coming months if inflation pressures persist. Knot said that the ECB should raise rates by 25 basis points in July, and a larger increase should not be ruled out if data shows inflation broadening and becoming more uncontrollable. The monetary policy minutes from the last ECB meeting will be published today and may give the market some greater clarity on the future path of interest rates.

USD

A key concern for markets at present is the tightening of monetary conditions in the US now that the Federal Reserve is engaged in a rate hiking cycle, with 50 basis points hikes expected at the next three policy meetings. This raises the cost of borrowing not only in the US but also across the global economy.

A shrinking Fed balance sheet meanwhile implies global liquidity conditions are drying up, which typically contributes to an economic slowdown. In addition, Covid lockdowns in China have meanwhile stalled the world’s economic growth engine, a situation only exacerbated by the war in Ukraine which has continued to promote safe-heaven flow for the dollar.