Out of Control

UK inflation is not coming down. Headline CPI inflation remained at 8.7% in May, refusing to come down as expected. And worst of all the core reading jumped even higher, rising from 6.8% to 7.1%, the highest since 1992. Andrew Bailey and co at the Bank of England have a remit to maintain stable inflation – they have demonstrably failed in this regard. They have a massive headache in the mortgage sector, undeniably, but that ought not to have prevented a more rapid effort to tighten. The risk is that we don’t just get high core inflation – we have that already – the risk is that it becomes entrenched for years; my fear is that the wage price spiral has also already arrived. That is why they needed to get ahead of the curve. It’s always felt that the inflation was less demand led, so no point in over-tightening, but it failed to realise that wages would take over the lead.  

Bowled a Googly  

The stickiness of inflation left traders raising bets the Bank of England has to go into a more hawkish stance this week and raised bets it will go with a 50bps hike tomorrow to 45%, with a full 75bps priced in to August and 6% Bank Rate by the end of the year. Back in February Mr Bailey said inflation was likely to have peaked – he forgot about core and the wage price spiral: driving that core inflation was service sector wages, the ONS said.  Rather like Mr Stokes, Mr Bailey declared victory far too early.  

UK Wallets Taking a Wallop 

Sterling spiked on the inflation report but gains quickly pared with GBPUSD finding it hard to make a move above 1.28 stick. Gilt yields spiked as traders priced in more hikes, with the 2yr up to a fresh 15-year high at 5.112%. Whilst there is an interest differential trade here regards USD, rising UK yields are not really a positive if higher rates push us into a recession….GDP falls 2% when rates hit 6%. Where is the breaking point for UK households? It’s not far off. Meanwhile UK net debt surpassed 100% of GDP for the first time since 1961…the records keep on coming! 

Why do we have this inflation?  

The obvious reasons are universal: the pandemic, supply shock, deglobalisation, way too much fiscal and monetary stimulus during the pandemic. But some UK-specific ones might include the lack of supply side reforms as the Tories are hamstrung in doing anything; Brexit could be a factor with new non-tariff trade barriers; the labour market remains incredibly tight (shortage of labour supply is key to the wage story); and the mortgage market has left the BoE with arguably less room for manoeuvre than others. But the BoE clearly failed to get a grip of the situation early enough. But to paraphrase the ECB president Christine Lagarde, we live in a more fragmented world with more disruption in global value chains as a period of global relative stability gives way to lasting instability, which will result in higher costs and likely a period of higher inflation. 

Elsewhere in the Market... 

Asian stocks slipped but the Nikkei rallied as the doves held sway at the central bank. The Bank of Japan’s governor Ueda was out on the wires this morning to reiterate the central bank thinks inflation will come down later this year. Core-core inflation in Japan recently hit a 40-year high. 

European stock markets were generally softer this morning, pulling back further from last week’s highs. The FTSE 100 dipped 0.6% to 7,517, its weakest in almost three weeks. The DAX fell 0.22% to 16,080 area, its lowest in over a week. US markets also fell yesterday as Wall Street reopened following the Monday holiday, with the S&P 500 down almost half a percent on the session – bearing in mind coming off a strong week and a lack of any fresh impetus to allow the broad market to kick on from its highest since April 2022. Traders are looking ahead to Jay Powell’s testimony after some housing starts data yesterday indicated the Fed might follow through with a couple more hikes.  

Cracks opening up in gold?