The pound rose against the euro, the US dollar and other major currencies after the release of better-than-expected UK inflation numbers. UK inflation rose to 2.1% for May according to the ONS, which is now above the Bank of England's 2.0% target.

High inflation means that the Bank of England could signal that it will tighten monetary policy soon, which will offer further support to Sterling.

Core UK inflation, which excludes the price of food, alcohol, tobacco and other volatile items, also rose to 2.0% in the 12 months to May, much higher than expected. This suggests that businesses are raising their prices following the lockdown due to rising costs. Most of the increases in music downloads inflation (from -5.1% to +3.4%) games, and hobbies inflation (from -0.6% to +2.7%), will be reversed in June, according to analysts.

UK Inflation

With the UK economy slowly emerging from the Covid-19 lockdowns, the cost of fuel, clothing and eating out increased pushing inflation across the UK higher and over the Bank of England’s target for the first time in almost two years. The UK consumer price index jumped to 2.1% in May, which is the highest CPI reading since July 2019.

The Office for National Statistics said that transport was one of the biggest sectors who boosted inflation, as petrol prices rose significantly. Prices for clothing, games and recording media rose, while meals and drinks consumed out also helped to increase the cost of living. Food and non-alcoholic beverages’ prices fell this year, after rising a year ago.

The rise of core inflation to 2.0% in the 12 months to May has created some concerns that inflation could rise over the Bank of England’s 2% target for longer than expected. BoE’s chief economist Andy Haldane stressed that Britain was at a dangerous moment, with “some pretty punchy pressures on prices” and the risk that prices could begin “a game of leapfrog”, and possibly lead to a wage-price spiral.

Inflationary pressures building up

There are signs that inflationary pressures are building up in the economy, with UK producer prices rising as manufacturers increased prices by 4.6% year-on-year in May 2020, up from 4% in April. These prices could eventually be passed on to consumers.

Pricier metals and crude oil costs helped to push input costs higher, with copper hitting a record high in May, and oil reaching pre-pandemic highs. The ONS said: “Transport equipment, and metals and non-metallic minerals provided the largest upward contributions to the annual rates of output and input inflation respectively.”

As Yael Selfin, chief economist at KPMG UK said these pressures will ease next year, which means that the Bank of England will probably resist raising interest rates soon. She noted: “Short-term inflationary pressures brought about by a perfect storm of rising oil prices, supply chain misalignments as the global economy reopens and border frictions with the EU, saw UK inflation rise to 2.1% in May, above the Bank of England’s target level of 2%. Changes to VAT will push inflation further this year, although we expect it to average 1.9% this year and 2.2% in 2022. There is a greater level of uncertainty about prices at present, with a possibility that inflation will turn out to be higher if staff shortages persist, triggering stronger wage rises, while cost increases continue to be passed on to consumers. However, with price pressures expected to ease next year and inflation to stabilise around 2%, it is likely that the Bank of England will hold fire and not raise interest rates before 2023.”

For those watching currency markets, the inflation numbers merely confirm that the UK economy is slowly improving, and this should be positive news for the pound as it will remain in demand.

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