Hotter-than-expected inflation leaves BoE between rock and a hard place

Inflation and the cost-of-living crisis remain major problems for both government and the UK central bank, and interest rates are only going one way.

UK September consumer price inflation hit a 40-year high of 10.1%, topping expectations for 10% and rising versus 9.9% in August.

Food made the largest upward contribution while the falling price of motor fuels made the largest downward offsetting impact. Food and non-alcoholic drinks prices rose by 14.6% in the 12 months to September, the 14th consecutive monthly rise and the highest since April 1980. This month’s reading is particularly important because it contributes to the government’s calculation of April’s rise in the state pension. 

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There’s no let up for price pressures in the UK economy right now, with inflation still the most pressing economic problem facing the Bank of England as well as the government. Without price stability, the cost-of-living crisis will continue to weigh on the economy by squeezing household budgets and dampening business margins. 

Today’s hotter-than-anticipated inflation reading paves the way for another aggressive interest rate increase from the Bank of England at its next meeting in early November as the central bank looks to curtail economic activity to bring price levels back towards its 2% target. However, the central bank is between a rock and a hard place as it looks to curb price pressures without inadvertently adding to the risk of recession. 

The new chancellor and his fresh economic strategy focused on reversing his predecessor's tax cuts, cutting spending and minimising borrowing will help to align fiscal policy with monetary policy so that the two complement rather than conflict each other. The Treasury’s fresh direction is expected to alleviate some of the UK’s price pressures by replacing stimulus with cutbacks. Having said that, Jeremy Hunt’s plans to reduce energy support from April will in fact add to upward price pressures by raising energy bills next spring. 

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Inflation is likely to peak somewhere around 11% in the coming months before easing back next year. The Bank of England’s terminal rate (the highest point in the interest rate cycle) is forecast to reach around 5% possibly higher at some stage in 2023 once price levels are more under control. 

The pound is trading modestly lower this morning, having enjoyed a boost at the start of the week thanks to optimism towards Hunt and his focus on fiscal discipline and sound money.