GBPUSD: Sterling dives against the US dollar as inflation fall gives Bank of England headache
Inflation fell significantly faster than expected by economists in March to hit its the lowest in a year, in a development which gives the Bank of England a “headache” as it looks to raise interest rates at its May meeting.
The consumer prices index (CPI), which the Bank targets, fell to 2.5 per cent, while the measure including housing costs (CPIH) fell to 2.3 per cent, according to data published today by the Office for National Statistics (ONS).
Slowing price rises for women’s clothing and tobacco were the main contributors to the disinflation, although the ONS noted that some of the effect came from changes to the timing of the Budget affecting tobacco levies.
Read more: British real wages are officially rising again
Nevertheless, economists had expected inflation to stay steady at the 2.7 annual rate hit in February. Sterling fell by as much as 0.7 per cent against the US dollar in the immediate aftermath of the data, with one pound buying less than $1.42, after hitting highs of $1.4315 earlier in the day.
The lower than expected figure will give a “headache” to the monetary policy committee (MPC) at the Bank of England, according to Ed Monk, associate director for personal investing at Fidelity International.
“The May MPC decision just became much tighter,” he said. “While still above target, the [downward] trend seems clear. Yet the Bank appears intent on tightening in response to rising wages.”
Inflation has fallen from a peak at 3.1 per cent in November – outside the Bank of England’s target range of one percentage point deviation either side of two per cent – after the devaluation of sterling following the Brexit vote fed through to higher prices.
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The fall in inflation, which has coincided with a rise in wage growth, has raised the prospect of an end to a year of sustained real wage squeezes. Yesterday the ONS confirmed that real pay rose in the year to February as wages both including and excluding bonuses rose by 2.8 per cent.
Another aspect in the Bank’s thinking will likely be that the end of the inflationary squeeze on consumers may allow more breathing space to tighten monetary policy, although the prospect of fiscal measures coming in this month may add pressure on consumers’ pockets from a different source.
Market expectations had previously showed the Bank as highly likely to raise bank rate in May, following its previous rate rise – the first in a decade – in November. That would likely leave bank rate at 0.75 per cent.
However, the lower than expected inflation reading could give some MPC members pause for thought. Doves on the committee have previously questioned whether there is truly an uptick in underlying inflation, as opposed to the devaluation raising import prices.
The fall prompted currency traders to immediately re-evaluate their bets on higher rates, a day after sterling hit its highest level against the dollar since the Brexit vote on 23 June 2016.
“Sterling had been appreciating on the expectation that a May rate hike was nailed on,” said Peter Ashton, managing director of Eiger FX. “However, that now seems much less likely and the currency markets have re-priced the pound accordingly.”
Read more: UK inflation fell to 2.7 per cent in February