UK bond markets sold off on Wednesday and traders expected further interest rate hikes after inflation fell far less than the Bank of England had expected.
The Office for National Statistics said consumer price inflation fell to 8.7% in April, from 10.1% in March, but well below the Bank of England’s forecast of 8, 4%.
Government borrowing costs soared on the numbers as traders revised their interest rate expectations upward.
The yield on two-year gilts jumped 0.22 percentage points to 4.36%, pushing them towards rates last seen after Liz Truss’ unfunded 2022 “mini” budget wreaked havoc on the financial markets.
Futures traders are now betting that rates will peak at around 5.3% by the end of the year.
“It’s clearly a big surprise for the whole community and we’ve seen a big reaction,” said Peter Schaffrik, economist at RBC Capital Markets. “It is very difficult to say with certainty that this environment will change in the short term – the UK labor market is still extremely tight.”
While a substantial decline had been widely anticipated due to the impact of factoring in energy price hikes early last year, core inflation for April rose to 6, 8% against 6.2% the previous month.
Food price inflation remained close to its 45-year peak, at 19.1% from 19.2% in March.
Inflation in the UK is now around double the equivalent US rate and significantly higher than in the Eurozone.
Wednesday’s figures will add to the difficulties of BoE Governor Andrew Bailey, who admitted the day before that the economic model of the central bank was not developed and that there were “very big lessons to be learned” on the management of sharp price increases.
While the overall rate of inflation is likely to fall further as gas and electricity prices fall this year, the jump in the core inflation rate – which excludes food and energy costs – suggests that there is more underlying inflationary pressure than expected.
Paul Dales, chief UK economist at Capital Economics, said while the headline rate cut was welcome, “far more important was the significant and worrying rebound in underlying inflation.”
He said this suggested “recent resilience in economic activity appears to be fueling domestic inflationary pressure.”
The BoE said it would raise interest rates again if inflation appeared to persist.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said Wednesday’s figures were well above expectations and were likely to prompt the central bank’s monetary policy committee to act again. There was “too small a drop [in inflation] for the MPC to stop hiking in June,” he said.
The ONS said the main rate had fallen due to more stable energy prices, but that was more than offset by substantial increases in the prices of used cars and cigarettes.
Kitty Ussher, chief economist at the Institute of Directors, said that while the numbers were concerning, there was still a chance that the drop in the headline inflation rate would alter sentiment among price- and wage-setting companies.
“Policymakers are hoping that now that the headline rate has returned to single digits, expectations for future inflation will also start to fall, which could then become self-fulfilling,” she said.
In April alone, UK prices rose 1.2% at a time when gas and electricity bills were frozen. There was an 8% increase in the communications component of inflation as mobile phone companies raised prices, measures often tied to the rate of inflation.
There was another 1.4% increase in food prices, the same increase in rents and holiday packages during the month and a 6% increase in postage.