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Shock February inflation rise makes policy missteps hard to avoid

22 March 2023

The surprising double-digit inflation in February is reminiscent of the 1970s.

By Matteo Anelli,

Reporter, Trustnet

UK headline inflation rose from January’s 10.1% to 10.4% in February, the latest data from the Office for National Statistics (ONS) showed.

The increase was mostly down to spikes in food prices, which were up 18.2%, the highest since 1977, and restaurants and hotels, whose prices rose 12.1%. Other components such as clothing and footwear also came in higher than expected, as James Lynch, fixed income investment manager at Aegon Asset Management noted.

“It really was a broad-based strong print which came as a big surprise to the upside that no one was expecting, including the BofE [Bank of England]. Today’s data will certainly raise some eyebrows at Threadneedle street, right before the policy-setting meeting,” he said.

The market was expecting the Consumer Price Index (CPI) to grow by single digits only, but energy prices and the weak pound have kept the figure high and rumours that the Bank of England would pause the interest-rate hiking cycle in tomorrow’s monetary decision have now been silenced.

Rob Morgan, chief investment analyst at Charles Stanley, said that the BofE “has little choice but to keep ratcheting up rates”, leaving UK households that are struggling to buy the essentials and make ends meet in “a miserable situation”.

Richard Carter, head of fixed interest research at Quilter Cheviot, agreed with this view and said hopes that rates at 4% would be enough are now shattered.

“Just last week the Office for Budget Responsibility (OBR) predicted inflation would be at 2.9% by the end of the year – a very steep drop off from the current level and an increasingly ambitious target following today’s print. How much the banking crisis will have changed this prediction remains to be seen, but it does feel a very punchy estimate,” he said.

“This has certainly been a unique set of circumstances that central banks have had to face. The fallout from the failures of Credit Suisse and Silicon Valley Bank only adds to the complexity and makes a policy misstep all the harder to avoid. The BofE may not be at the end of its interventions yet.”

But it won’t be the banks but the labour market that the BofE will focus on, according to Susannah Streeter, head of money and markets at Hargreaves Lansdown.

“Although the banking turmoil will be front of mind, this latest snapshot and ongoing worries about a tight labour market are likely to tip the balance in favour of a rate hike,” she said.

The banking scare, however, will prove a disinflationary force if loans are a bit harder to come by. The housing market is already reeling from the effects of a spike in mortgage rates and if lenders turn more cautious, it could be another gut punch, said Streeter.

“So given the potential headwinds which could whip up, the risk is that a hike now could end up pushing inflation below target further down the line. This is likely to be more of a background concern for policymakers right now, particularly as action to stem contagion in the banking sector appears to be working, but it may still mean a hike tomorrow will be the last one in the line.”

Rachel Winter, partner at Killik & Co, was also cautiously hopeful.

“With the OBR forecasting inflation is set to reduce to 2.9% by the end of 2023, today’s reading is hopefully just a bump in the road to getting inflation back under control,” she said.

“Despite this, the reality is that prices remain high, the cost-of-living crisis persists, and inflation continues to hit people’s cash reserves. These issues pose tough questions to investors who want to ensure they have enough cash holdings but are also making smart investment choices to help mitigate inflationary erosion.”

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