The pound was on course for one of its best days of the year after inflation data came in ahead of forecasts, raising expectations of a hawkish slant from the Bank of England when its Monetary Policy Committee meets on Thursday.
Sterling rose 0.9 per cent at $1.3277 after the data, its highest level against the dollar since September 2016. Against the euro, it strengthened by 0.6 per cent with £0.9012 required for a unit of the shared currency, also its strongest intraday level since August 4.
Speaking before the inflation numbers came out, Geoff Yu, head of UBS Wealth Management’s UK Investment office said the data “could be the last stand to keep any hawkishness alive, not just for this week but for the rest of the year as the market’s base case is for no tightening this year”.
Shilen Shah, bond strategist at Investec, said the BoE had been patient with previous data pushing inflation above target, but added that “some reduction in the dovish bias and a move towards a more neutral or even a few hawkish comments is currently expected by the market”.
Inflation, as measured by the consumer price index, rose 2.9 per cent year on year in August. The Office for National Statistics said although sterling depreciation was likely to increase the cost of imports, “other factors determine whether these are passed on to consumers”, such as increasing commodity prices globally and business protecting themselves against exchange rate volatility.
But Ben Brettell, senior economist at Hargreaves Lansdown, cautioned investors to expect this to mark inflation’s peak.
“ . . . the effect of Brexit-induced sterling weakness falls out of the year-on-year calculation. Indeed it’s possible that 2.9 per cent will be the highest we see in the current cycle,” said Mr Brettell.
Beyond the currency effect, there seemed to be few underlying inflationary pressures, he added, pointing to below-average labour costs growth, sluggish productivity growth and suppressed wages.
But Roger Hallam at JPMorgan Asset Management said an inflation rate still trending above 2 per cent, coupled with falling unemployment, increased the risks of a November hike in rates.
“In any normal time, the BoE would be hiking rates,” said Mr Hallam. “The BoE would rather not hike rates because of uncertainty caused by Brexit — it may well feel it’s at risk of making a mistake if the economy slows next year.
“But it has an inflation mandate. Growth data have looked a bit more mixed, but the inflation side of the mandate suggests the trade-off becoming more balanced.”
Robert Wood, UK economist at Bank of America Merrill Lynch, said he expected “a more hawkish BoE statement after Thursday’s policy meeting”, adding that the MPC may argue the market is underpricing the chances of a rate hike.
But Mr Wood expected the balance on the MPC to remain at 7-2 in favour of keeping rates on hold. A new member, David Ramsden, is likely to side with the doves, although deputy governor Andy Haldane was “the one to watch”.
UK government bonds were sold as investors priced in the greater likelihood of a rate rise by the BoE. The 10-year gilt yield, which moves opposite to the bond price, added three basis points to 1.08 per cent.