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What are UK inflation expectations after the recent slowdown?

Inflation fell back down to the Bank of England’s 2% target in July, in an unexpectedly sharp slowdown, which some economists said was most likely a blip as the reopening of the economy after lockdown should keep driving prices higher.

Sterling showed little reaction to the figures as investors judged they were unlikely to alter the rising trend for inflation and would not sway Bank of England (BoE) policymakers much. Earlier in August, the BoE said it expected to tighten monetary policy moderately over the next three years and that it expected inflation to jump to 4.0% by the end of this year, which would be a decade high.

July’s slowdown in inflation reflected a jump in prices in the same month last year when Britain’s economy was emerging from its first coronavirus lockdown.

Market opinion
Commenting on the UK CPI inflation coming in at 2%, Olivier Konzeoue, FX sales trader at Saxo Markets, said: “CPI rose by 2% in the 12 months to July 2021, down from 2.5% in June and below the 2.3% expected. This is the first time UK inflation has fallen back to 2% since April and the first time in a while that UK CPI doesn’t match economists’ consensus. This drop can be partly explained by the sharp rise in prices observed in July 2020 as lockdown restrictions were eased more broadly.” 

Konzeoue added: “This slowdown in inflation is broadly regarded as a blip. The clothing and footwear sector saw the largest downward contribution, while prices for transport represented the largest upward contribution. All in all, inflation in the UK is expected to pick up again in the coming months although base effects could create some further noise in future data. Investors may have just had a glimpse of how sharply inflation could fall once distortions implied by the pandemic have faded.” 

Rupert Thompson, chief investment officer at Kingswood, added: “Despite the latest decline, inflation still looks set to pick up sharply later this year to 4% before retreating again next year. These numbers should do nothing to dissuade the MPC from its view that a modest tightening of monetary policy is likely to be needed over the next couple of years.”

Ian Warwick, managing partner at Deepbridge Capital, said of the data: “While inflation may have slowed slightly to fall within the Bank of England’s target of 2% this does not mean that rates won’t pick up over the coming months. Many early-stage businesses will be thriving in the recently reopened economy, but they will continue to watch the debate around the decision on a subsequent rise in interest rates very closely as this will directly impact how much they are able to borrow at a crucial time. 

“With inflationary pressure continuing it raises the question of exactly how long the Bank of England can hold interest rates at current levels before it is forced to step in, subsequently causing a problem for growing, early-stage companies who require access to funding as we focus on economic recovery.” 

Douglas Grant, director at Conister, part of AIM listed Manx Financial Group, commented: “The UK isn’t currently experiencing runaway inflation like in the US. This is not to say that rates won’t pick up over the coming months as more of the pandemic cost burden is passed onto consumers, but as per the recent UK GDP data, we are seeing more encouragement for the future of the UK economy. One area of concern however is current business default levels caused by the ongoing impact of the pandemic and we must acknowledge that the UK’s business debt burden has ballooned to unprecedented levels and unfortunately this has already created a relentless flow of weak ‘zombie-like’ companies falling off a loan default cliff. It is imperative that we support sectors and businesses that are strong and nimble enough to adapt to the new economy and therefore continue contributing to its growth. 

“We also believe that the introduction of the Recovery Loan Scheme (RLS) will act as second support system for those businesses currently struggling but with long term growth potential. Indeed, we have been pleased to see the Government look beyond the obviously more resilient business sectors and introduce the RLS, which can support those businesses that have been mostly negatively impacted by Covid-19, such as the hospitality and leisure sectors.” 

Lastly, Ben Carter, analyst at Validus Risk Management, said of the inflationary slowdown: “The BoE will hope this is a sign of transitory inflation, but with Covid-19 partially closing a busy Chinese port late last week, it’s clear the supply side inflation may be with us for some time yet.

“This will ease pressure on the BoE to offer forward guidance at the September policy meeting, and another report at, or below, 2% in September could see market expectations of a rate hike in the middle of 2022 be pushed back.”

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