This Wednesday will be the longest day of the year and not long after sunrise the Office for National Statistics (ONS) will release its latest Cost of Living Bulletin. To say the dates are highly anticipated is an understatement. It is unlikely that more significant official data will be released in the current parliament.
The reason is simple. Despite interest rates having been hiked 12 times since December 2021 to dampen upward pressure on prices, turning inflation is proving harder than the Bank of England imagined.
Threadneedle Street’s Monetary Policy Committee (MPC) will meet on Thursday to decide what to do with interest rates. Inflation has been higher than expected in recent months and another disappointing reading would rock financial markets.
The bank will not pay much attention to the headline inflation rate as measured by the consumer price index (CPI), which currently stands at 8.7%. Instead, the two numbers to watch for are service sector inflation and CPI inflation excluding energy, food, tobacco and alcohol (core inflation). Both are viewed as indicators that price pressures are generated by the domestic economy and are therefore not distorted by global factors or government decisions.
When the MPC last met in early May, it raised the official cost of borrowing by a quarter of a point to 4.5%, and there was hope that the peak of the interest rate cycle had either been reached or was imminent.
Such hopes have since been dashed. In the latest published inflation numbers, service sector inflation rose to 6.9% from 6.6%, while core inflation rose to 6.8% from 6.2%. Since the release of the latest jobs data last week, which showed an acceleration in annual wage growth, markets have been betting that the peak will come in at 5.75% rather than 4.5%. Mortgage rates soared as lenders re-rated their mortgages. The cost of government borrowing rose to levels not seen since the global financial crisis 15 years ago, exceeding levels during Liz Truss’ brief and tumultuous tenure.
Any new indication that inflation is proving “stubborn” will immediately pressure the bank to tighten its stance. George Buckley, a Nomura economist, expects the MPC to be split in three directions: six members will vote for a 0.25 percentage point increase, two will vote for no change, and one will vote for a 0.5 percentage point increase percentage points. A higher than expected inflation number would increase the probability of a rise by half a percentage point.
So Wednesday is crunch time. It’s crucial for Rishi Sunak and Jeremy Hunt, who want voters to judge the government on the progress it’s making in fighting inflation and calming markets. Halving inflation in 2023 was one of PM’s five New Year promises in January, but the decline has been slower than expected so far. To have any hope of winning the next election, Sunak and Hunt must cut interest rates quickly.
It is high time for the bank, which is tasked with meeting the government’s 2% inflation target, and is now facing increasing criticism. So far, criticism has tended to come from those who say the bank has been too slow in responding to price pressures and allowing inflation. But there are also those who say the bank risks plunging the UK into a deep recession because interest rates are lagging.
Wednesday is also a time of crisis for the UK housing market and the millions of people paying mortgages. According to the ONS, 57% of those who took out fixed-rate home loans did so when interest rates were below 2%. Those whose contracts are due to expire in the coming months will be refinanced at three times those rates.
And with mortgage rates affecting housing demand and consumer confidence, Wednesday is the time of the crisis for the economy. Great Britain just managed to avoid slipping into recession in the winter. There is no guarantee that this will continue to be the case.