UK Inflation Boosts Sterling

The latest reading of inflation for August suggests that it is running at 2.9% according to the UK’s Office for National Statistics. The value quoted is for the Consumer Price Index (CPI) and has come in above analysts’ expectations. Inflation is now back at the peak seen in May which means it is running at the highest rate seen for five years and is significantly above the Bank of England’s target figure of 2%.

The ONS has suggested that the fall in Sterling which occurred after last June’s referendum shock is having an impact on the prices of imported goods as price rises work their way through supply chains and businesses can no longer afford to absorb them to the extent they had been. An additional factor is that crude oil prices have risen, pushing up the cost of fuel (this is exacerbated by the decline of Sterling against the Dollar from a pre-vote level of $1.49 to its current value of $1.33). Average prices for petrol and diesel rose by 1.8 and 2p per litre, pushing the prices up to £1.16 and £1.18, respectively.

Clothing and footwear costs contributed to inflation mainly due to higher import costs with year-on-year inflation running at a record 4.6%.

The higher inflation level has boosted Sterling to its best level against the Dollar for a year on speculation that the Bank of England will decide to increase interest rates as a mechanism to rein-in inflation. This is probably premature as the Bank is still trying to be accommodative to businesses as Brexit uncertainty rages.

UK wage inflation is currently running at 2.1% annually (new data is due out later today) which means that household disposable income is falling. To an extent, increasing the interest rate would have this effect by pushing up the costs for mortgages and personal loans, so it is unlikely that the Bank will take early action on interest rates. This means that Sterling is likely to give up its recent gains once the market factors this in.