UK inflation surprises significantly to the upside

Emily Nicol
Chris Scicluna

UK inflation again beats expectations with further rise in core inflation in May heaping more pressure on BoE
Once again, the latest UK inflation data surprised significantly on the upside to underscore the likelihood of further substantive BoE tightening over coming months. Certainly, the UK now has the biggest inflation problem of all major economies. And, with the BoE having insisted that policy is data-dependent, the swaps market is now fully pricing Bank Rate to reach 6.00% by year-end, a level that would represent additional tightening of 150bps and would seem certain to cause recession next year. At least the headline CPI rate failed to rise in May, remaining at 8.7%Y/Y. But that comfortably exceeded the median forecast on the Bloomberg survey of a drop of 0.3ppt and left inflation trending a full 0.5ppt above the BoE’s forecast for Q2 published last month. And more importantly, the core CPI rate rose a further 0.3ppt to a new three-decade high of 7.1%Y/Y, dashing hopes that this measure of underlying pressure would at least stabilise.

Within the detail, further upwards impetus to inflation in May came from services (up 0.5ppt to 7.4%Y/Y), with air fares, cultural activities (e.g. cinemas, theatres and concerts) and communications key drivers. Moreover, despite evidence in other major economies of a cooling in global factory-gate prices, core goods inflation also rose (up 0.3ppt to 7.1%Y/Y), pushed higher by toys and games, second-hand cars and clothing and footwear. Lower petrol prices, however, meant that energy inflation eased almost 2½ppts to a two-year low of 8.4%Y/Y. And inflation of food and non-alcoholic beverages eased 0.7ppt, but remained extremely high at 18.3%Y/Y.

Looking ahead, base effects with energy and food, as well as the cut in the regulated household energy price cap in July, will at least push headline inflation lower over coming months. And a drop in producer output price inflation in May (down 2.3ppt to a 26-month low of 2.9%Y/Y) also suggests that core goods inflation should moderate. However, the jump in private sector wage growth in April amid the still-tight labour market augurs badly for services inflation. And with the level of competition in the UK economy seemingly diminished by Brexit, a recession might well now be pre-condition for core inflation to get core inflation back to levels consistent with 2% inflation over the medium term. Certainly, the BoE will no longer trust its forecast that inflation will return smoothly to its target over the projection horizon. And we definitely cannot rule out the possibility that the MPC will tighten by 50bps tomorrow, to take Bank Rate to 5.0%, and signal the likelihood of further tightening to come too.

Reuters Tankan survey signals that manufacturers are more upbeat, with increased optimism led by autos sector
Today’s monthly Reuters Tankan – which offers a guide to the BoJ’s quarterly Tankan published at the start of next month – signalled a further pickup in Japan’s recovery momentum at the end of Q2, with manufacturers the most upbeat about conditions so far this year. In particular, the headline manufacturing diffusion index (DI) rose for the second successive month in June, by 2pts to 8, to leave the average index in Q2 up 9pts on the quarter. Amid the ongoing moderation in supply constraints, the improvement was largely driven by the autos sector, for which the DI jumped to its highest since August 2021 (up 22pts to +30), which helped offset increased pessimism among electrical machinery manufacturers.

Sentiment among non-manufacturers edged slightly lower in June, down 1pt to 24, but this was from joint-highest level for four years in May. And over the second quarter as a whole, the index was 5pts higher than in Q1 at 24, this highest reading since Q219. While confidence among retail and construction firms slipped back this month, the respective indices were down from multi-month highs. Indeed, when smoothing for monthly volatility, the quarterly retail DI was up 7pts to 21 in Q2, the highest since the survey began in 1998, while the construction index was 14pts higher in Q2 at 4.

Recovery in euro area car registrations supported by easing supply constraints, but French retail sales suggests that demand for other goods remains weak
This morning’s new car registrations figures published by ACEA suggested another month of solid growth in May as supply bottlenecks continued to ease. In particular, new car sales in the euro area rose 20%Y/Y, with accelerated growth in Germany (19.2%Y/Y) and double-digit growth in France (14.8%Y/Y) and Italy (23.1%Y/Y). Despite the recent recovery, however, total new car registrations in the region still remain almost a quarter below the equivalent month ahead of the pandemic. The improvement in May tallied with the Bank of France’s latest retail sales survey, which saw new car sales jump 10%M/M to the highest level since August 2021, albeit remaining some 12½% below the pre-pandemic level in February 2020. But this was largely offset by declines in sales of food, clothing, perfumes and household appliances. Indeed, total retail sales rose just 0.4%M/M in May. And coming on the back of the steep decline April (-2.1%M/M), this left retail sales so far in Q2 trending more than 1% below the Q1 average.

Powell’s monetary policy testimony to Congress set to signal further policy tightening ahead
Focus in the US today will be firmly on Fed Chair Powell’s semi-annual monetary policy testimony to the House Financial Services Committee, where we expect him to maintain a relatively hawkish tone, reiterating the message from last week’s policy-setting meeting that the inflation outlook likely justifies further policy tightening this cycle and that the next FOMC meeting on 25-26 July is very much a “live” meeting.

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