Rise in UK inflation leaves central bank caught between growth and rising prices
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3 min read . Updated: 16 Feb 2022, 07:23 PM IST Consumer prices rose at their fastest annual rate in three decades in January
LONDON : Inflation in the U.K. rose at its fastest annual rate in nearly three decades last month, keeping up the pressure on the Bank of England to raise its benchmark interest rate again.
The BOE has already raised its policy rate twice in recent months, moving faster than any other major central bank to curb prices that have surged due to global supply shortages and higher energy costs.
Soaring inflation is presenting policy makers in the U.K. and elsewhere with a stiff challenge. They must raise interest rates to tame inflation that threatens to spread further, but without choking off the recovery and tipping their economies into a recession.
The looming threat of a Russian invasion of Ukraine is further muddying the outlook for policy makers, with the risk it could further drive up energy prices.
Consumer prices in the U.K. increased 5.5% in January compared with a year earlier, the Office for National Statistics said Wednesday—the highest since March 1992. In December, consumer prices rose 5.4% year-over-year. Clothing and footwear largely contributed to the increase in January, coming on top of rising costs of some household goods and rent.
The latest data will likely strengthen the case for a third consecutive rate increase when the BOE meets next month. The Federal Reserve is also moving to tighten monetary policy after inflation hit another four-decade high in January, accelerating to a 7.5% annual rate.
In the U.K., inflation is on course to peak above 7% in April, according to the BOE, when higher wholesale gas prices are passed on to U.K. consumers.
At its last meeting, the BOE signaled further modest tightening would likely be necessary to bring inflation back down to its 2% target.
The BOE expects annual inflation to recede to 5% by the start of 2023.
Four of the nine members of the BOE’s rate-setting panel voted for a bigger rate increase than the 25-basis-point increase they finally agreed, reflecting concern that inflation is seeping into other parts of the economy.
“With that in mind, I suspect it would take a material change to the growth outlook to stop the committee hiking again in March," said James Smith, developed markets economist at ING.
At 0.5%, the BOE’s policy rate currently sits a quarter of a percentage point below where it was before the pandemic. Economists expect further rate increases to come more slowly as inflation eases over the course of the year due to energy prices leveling out.
“To justify the six further rate rises markets are pricing this year, we need to see signs of a wage-price spiral," said ING in a note. “We aren’t convinced that is likely."
While wage growth gained momentum toward the end of last year, British households are facing the biggest drop in real incomes for 30 years because of inflation and a planned tax rise in spring. That is set to weigh on growth as consumers cut back on spending.
The U.K. grew 7.5% last year—the strongest performance among the Group of Seven largest rich economies. But having suffered the largest slump in 2020, it had further to climb to regain its pre-pandemic size. And the economy contracted in the past month of 2021 as the Omicron variant hit hospitality and other consumer services.
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