This Wednesday will mark the longest day of the year and shortly after sunrise the Office for National Statistics (ONS) will release its latest cost of living bulletin. To say the data is eagerly awaited is an understatement. More official data is unlikely to be released in the current parliament.
The reason is simple. Despite raising interest rates 12 times since December 2021 in an effort to quell upward pressures on prices, inflation is proving harder to redirect than the Bank of England imagined.
Threadneedle Street’s Monetary Policy Committee (MPC) will meet on Thursday to decide what to do about interest rates. Over the past few months, inflation has exceeded expectations and another disappointing number would rattle financial markets.
The Bank will not pay much attention to the headline inflation rate as measured by the Consumer Price Index (CPI), which currently stands at 8.7%. Instead, the two numbers to watch are service sector inflation and CPI inflation excluding energy, food, tobacco and alcohol (core inflation). Both are considered indicators of price pressures generated by the national economy and are therefore not distorted by global factors or government decisions.
When the MPC last met in early May, it raised official borrowing costs by a quarter of a percentage point to 4.5% and there was hope that the peak of the rate cycle would d interest has arrived or is close.
These hopes have since been dashed. In the latest set of inflation figures released, service sector inflation fell from 6.6% to 6.9%, while core inflation fell from 6.2% to 6, 8%. Since the release of the latest labor market data last week showing a recovery in annual wage growth, markets are betting on rates peaking at 5.75%, not 4.5%. Mortgage rates soared as lenders re-evaluated their home loans. Government borrowing costs have reached levels not seen since the global financial crisis 15 years ago, surpassing levels seen under the brief and turbulent leadership of Liz Truss.
Any new evidence that inflation is proving to be “sticky” will put immediate pressure on the Bank to toughen its stance. George Buckley, an economist at Nomura, thinks the MPC will be split in three, with six members voting for a 0.25 percentage point increase, two opting for no change and one for a 0.5 percentage point increase. A higher than expected inflation figure would increase the chances of a jump by half a point.
Accordingly, Wednesday is the critical time. This is a critical time for Rishi Sunak and Jeremy Hunt, who want voters to judge the government on the progress it is making in tackling inflation and calming markets. Halving inflation by 2023 was one of five New Year promises made by the prime minister in January, but the decline so far has been slower than expected. To hope to win the next election, Sunak and Hunt need interest rates to come down quickly.
This is a critical moment for the Bank, which is tasked with meeting the government’s 2% inflation target and is now facing mounting criticism. So far, criticism has tended to come from those who say the Bank has been too slow to react to price pressures and allowed inflation to take hold. But there are also those who say that because interest rates are operating with a lag, the Bank risks plunging Britain into a deep recession.
Wednesday is also a critical time for the UK property market and the millions of people paying mortgages. The ONS says 57% of those who took out fixed rate home loans did so when rates were below 2%. Those whose agreements expire in the coming months will refinance at three times those rates.
And because mortgage rates affect housing demand and consumer confidence, Wednesday is a critical time for the economy. Britain virtually avoided falling into recession over the winter. There is no guarantee that it will continue to do so.