UK inflation may be combated by tightening monetary policy


Sterling ended the week close to one month highs on Friday as UK bond yields rose amid growing expectations that the Bank of England (BoE)  may soon tighten economic policy to combat rising inflation.

The move follows hawkish comments from Governor Andrew Bailey who hinted that the BoE were considering tightening policy. Bailey told lawmakers in Parliament on Thursday that whilst economic growth was stalling there was a 4-4 split between policymakers as to whether or not the economy had recovered enough to meet the minimum conditions for a rate hike, with Bailey admitting he was one of those who think the minimum criteria has been met.

Bailey’s comments were welcomed news for sterling. The currency had initially traded close to range lows after a string of disappointing data releases and news that the UK government were planning to hike National Insurance contributions – this had caused investors to re-think hawkish BoE expectations.

Crucially, money markets are now currently pricing in a 15 basis points rate increase early next year with a 35 basis points rise expected at the end of the year. This will position the UK ahead of the Federal Reserve and European Central Bank as the first central bank to normalise monetary policy post-Covid.

Friday saw the release of Manufacturing data and the last GDP figures which both missed expectations. This would usually result in sterling trading lower but optimism surrounding rate hike expectations overshadowed the data. It may also be the case that the stall in recent data could be owed to recent supply chain issues, leading investors to view the recent stall as a temporary one.

Investors will turn to this week’s employment and inflation data, placing more weight on the data released after Governor Bailey’s admission last week. Any indication that the jobs market is showing resilience following the winding down of the furlough scheme will give sterling a boost, whilst a strong inflation reading may also support claims that the minimum threshold for a hike has been met.