The Bank of England meets next week and inflation is remaining a serious problem. Short-term interest rate markets are pricing in a 99% chance of a 25bps rate hike on May 10 after the latest inflation data.
The recent headline inflation in the UK remains in double digits at 10.1% y/y for March. This is above the 9.8% y/y that economists were expecting. This will eventually fall down as a significant part of the high inflation pressure came due to artificially high energy prices. So, the headline should fall more sharply moving forward. However, the core inflation print is tricky. Visually, the problem is obvious. The headline inflation is showing signs of ‘stepping’ lower.
Contrast that with the core inflation reading.
Do you see the issue? The core is stickier and looks set to remain that way. The recent wage data from the UK came in higher for February at 6.6% 3m/yr which exceeded economists’ expectations that will keep the pressure on the BoE. Unemployment is currently at 3.8% which is below pre-pandemic levels, so the labour market is still tight. Furthermore, public services have been striking for pay increases from railway workers to doctors, nurses, and teachers. This keeps the inflationary pressure building.
So, the UK runs the risk of being thrown into a sharp recession now. Higher inflation will lead to higher interest rates which could quickly slow the economy. So, what will the BoE do? Will it prioritise inflation and keep hiking rates even if a recession looks more likely? Or will the BoE prioritise growth and pause on rates in a surprise move? The problems are clear, but the solution is not. This means that traders should watch the GBP carefully. The EURGBP pair would be a good pair to express a GBP move as the ECB and the BoE are facing similar problems.