British interest rates likely heading much higher on inflation reading

Core inflation in July was unchanged at 6.9% from June

Wed, 16 Aug, 2023 - 16:25

Samuel Indyk and Joice Alves

Sterling rose sharply as the latest British inflation numbers reinforced bets that the Bank of England will likely hike interest rates again.

Sterling surged 0.35% against the dollar to $1.275 and climbed to 85.68 pence against the euro. The headline rate of UK consumer price inflation slowed to 6.8% in July, but core inflation, which strips out volatile food and energy prices, was unchanged at 6.9% from June, and higher than economist expectations for a reading of 6.8%. Services inflation picked up to 7.4% from 7.2% in June.

"Core inflation remains stubbornly high at 6.9% and is now slightly above the headline level," said Oliver Blackbourn, multi-asset portfolio manager at Janus Henderson Investors.

"This presents a headache for the Bank of England as it will want to see this less volatile measure decline to suggest that cost pressures are sustainably returning to target."

House prices

A separate set of data showed that British house prices increased by 1.7% in the 12 months to June, the smallest rise since July 2020, as Britain's housing market has come under strain from higher mortgage rates after 13 back-to-back Bank of England interest rate hikes.

British wages grew at a record pace in the second quarter, data on Tuesday showed, adding to the Bank of England's inflation worries. Money market traders now fully price a 25 basis points, or quarter point, hike at the central bank's next meeting in September. But amid stubborn inflation, they have started to price in around a 10% chance of a larger half-point rate rise, according to Refinitiv data.

Worse, markets also price in a total of 75 basis points of rate hikes by February, implying the Bank of England's bank rate would hit 6%, up from 5.25% currently.

"It's clear that the extent of UK monetary policy tightening required will be more substantial than in the US and eurozone," said Hussain Mehdi, macro and investment strategist at HSBC Asset Management.

"The persistent shortfall in UK labour supply is translating to upward pressure on wages, and thus the need for a 'higher-for-longer' interest rate scenario."

Increases in the price of airline tickets and hotels helped to keep British inflation at an elevated rate. There also was a 1.7% increase in the cost of renting property — mainly in public housing.