The pound strengthened against the euro and hit a new 2021 high following the release of inflation data. UK headline CPI inflation rose 4.2% year-on-year in October according to the ONS and was higher than last month's 3.1%. The inflation rate is the highest in a decade since November 2011, when the CPI reached 4.8 percent.

The rise in inflation has strengthened market sentiment as investors are now expecting the Bank of England to raise interest rates in December. Both Tuesday’s labour data and inflation data on Wednesday show that an interest rate hike is more likely, as the Bank might not be able any longer to keep interest rates at historic lows.

Inflation data

CPI inflation rose 1.1% month-on-month and core CPI inflation rose 3.4% in October. Input inflation at factories remained strong with PPI input prices rising 13.0% year-on-year in October. October’s inflation rise was driven by 11.9% month-on-month rise in utility prices. Food inflation rose from 0.9% to 1.3% and fuel inflation from 17.8% to 21.5%.

Capital Economics have said that despite rising inflation, CPI inflation will fall back in the second half of next year, perhaps closing on the Bank of England's 2.0% target by December 2022.

So even if interest rates rise from 0.10% to 0.25% in December and even 0.50% in February, Capital Economics don’t think that rates will reach the level of 1.00-1.25% currently priced into the market for the end of 2022.

Governor Andrew Bailey “very uneasy” about rising inflation

Bank of England governor told MPs that he was “very uneasy” about the UK’s rising inflation rate.

While providing evidence to the Commons Treasury select committee, Andrew Bailey said that the rising cost of living was troubling and said that “all meetings were in play” as the Bank could start tightening its policy at any of its upcoming meetings.

The Bank anticipates inflation to increase at 5% next spring, but Bailey said he avoided voting for a rise in borrowing costs this month because he wanted more evidence on the market after the end of the furlough scheme. He noted “I’m very uneasy about the inflation situation. I want to be very clear on that. It is not, of course, where we wanted to be, to have inflation above target. On the decision itself, however, it was a very close call in my view.”

He explained that anecdotal evidence suggested that there was no significant rise in unemployment after the closure of the furlough scheme at the end of September. In regard to markets’ disappointment following the Bank’s decision to keep interest rates unchanged earlier in November, Bailey said that neither he nor any other Bank policymaker had ever promised a November rate rise.

Monetary Policy Committee member Michael Saunders, who voted for a November increase, said that delaying action might lead to interest rates rising faster and further in the future.

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