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Does 3% inflation make an interest rate hike imminent?

19 October 2017

Inflation levels in the UK rose to their highest level since 2012 in September, fuelling the expectation of an interest rate hike.  

Official figures from the Office for National Statistics showed inflation crept up to 3% in September from 2.9% in August, as higher transport and food costs led to a widespread increase in prices. It marks the highest rate since March 2012.

The figures come ahead of the Bank of England’s meeting in November, and were just shy of the 3.1% level that would require governor Mark Carney to write a letter to the Chancellor explaining why the figure is considerably higher than the central’s bank 2% inflation target.

Thomas Wells, manager of the S&W Global Inflation-Linked Bond Fund, said: “Most economists would regard this as ‘bad’ inflation because it has been driven by rising input costs and unfavourable FX impacts, rather than strong consumer demand. Inflation has remained more persistent than the Bank of England had first hoped, causing Mark Carney to adopt a significantly more hawkish tone in the run up to the November MPC meeting.  However, these hawkish comments have themselves encouraged sterling to strengthen, helping to stem further FX-related inflation without threatening the already weak GDP numbers.”

Viktor Nossek, director of research at WisdomTree in Europe, said: “While an eye-catching number, the real question is if beyond the peak, inflation will trend lower and be contained enough to sustain consumer spending. Against poor productivity, wages are expected to struggle to even keep up with lower inflation further out.”

However, Ian Browne, retirement planning expert at Old Mutual Wealth, said the rise in inflation proved positive for pensioners, who will arguably be the biggest winners from the higher figures. Under the government’s “triple lock” guarantee, the state pension will rise in April each year by whichever number comes in highest out of the inflation figure, average earnings or 2.5%.

Browne explained: “The new inflation rate will see the flat-rate state pension rise by £4.78 a week. Although a modest increase, in an environment where pay growth lags inflation pensioner incomes will keep pace with prices while the working age population feel the squeeze,” he said.

Andrew Tully, pensions technical director at Retirement Advantage, described the inflation increase as a “double-edged sword”, benefiting current pensioners but proving a challenge for those still working.

He commented: “On the one hand key state benefits including the State Pension will increase by at least 3% due to the triple lock, meaning millions of pensioners will benefit from April. Public sector pensions in payment are also linked to September’s inflation data and will also increase. The sting in the tail though for anyone trying to make ends meet is the seemingly never-ending rise in the cost of living. With households needing to find an extra £825 a year to maintain their standing of living, and with wages lagging behind, living standards will continue to be affected.”

While the state pension is set to rise, so too are interest rates with experts believing a hike to be imminent. The question is, will further increases follow?

Wells added: “Given market sentiment, it appears that Carney will have to follow through and raise rates in November to maintain credibility. Any accompanying commentary will be closely scrutinised to assess the likelihood of further hikes but given the fragility of current financial conditions, we deem November sparking the start of an aggressive tightening cycle as highly unlikely.”

Nossek said: “There has been much talk of a rate hike later this year by the Bank of England, but with so many areas of weakness in the economy, and high levels of indebtedness, a rate rise could be a step too far for the Bank of England, at least until there is more clarity on Brexit.

“The deciding factor could be the pound, but even here the outlook has become more benign, with the currency appreciating substantially off lows and acting as a dampener on inflation.”

Nathan Sweeney, senior investment manager at Architas, said the prospect of a rate-raising cycle was unlikely.

“We believe the ability of the Bank of England to enter a rate rising cycle is severely limited by the slowing growth we are seeing in the UK. In the face of high inflation we are still seeing little wage growth so the pressure is continuing to grow on UK households. This will make it hard for the Bank to make any sustained move to raise rates in the short to medium term,” he said.

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