UK CPI, Stagflation And The Road Ahead
The UK Consumer Price Index (CPI) remained at 3.8% year-on-year in September, contrary to expectations of a rise to 4.0%. The data showed core inflation below expectations with no monthly change in both headline and core figures. Disinflation in food…
The UK Consumer Price Index (CPI) remained at 3.8% year-on-year in September, contrary to expectations of a rise to 4.0%. The data showed core inflation below expectations with no monthly change in both headline and core figures. Disinflation in food prices was noted, although it was counterbalanced by increased fuel costs. The market interpreted this as progress towards the Bank of England's (BoE) target, resulting in firmer gilts and a softer sterling.
Two factors contribute to the BoE's cautious stance. Firstly, services inflation remains at 4.7%, well above the 2% target. Secondly, the consistent 3.8% CPI over the past two months indicates stability rather than a full resolution. While there is a greater possibility of a rate cut in December, additional reductions in services and pay inflation are likely necessary before decisive action is taken. The trajectory towards easing appears to be reinforced by the current data.
The data has assuaged some concerns about stagflation, characterized by weak growth and rising inflation. The UK's growth is sluggish, but inflation is not increasing; it remains at 3.8% with a slow decline. This indicates a "sticky disinflation" scenario rather than an inflationary spiral. If services inflation remains high while economic activity declines, the risk of stagflation could rise. However, the current CPI composition reduces the likelihood of stagflation re-emerging in the near term.
Softer inflation figures typically limit sterling rallies against the USD and EUR, maintaining a range-trading bias until data accelerates or the BoE responds. Divergence between the BoE and the Bank of Japan keeps attention on GBP/JPY, where potential BoE easing and BoJ normalization could lead to a downside in GBP/JPY.
The UK Consumer Price Index (CPI) remained at 3.8% year-on-year in September, contrary to expectations of a rise to 4.0%.
A combination of disinflation and easing supports rate-sensitive stocks, such as homebuilders and utilities, and those most exposed to the UK economy. Banks may experience medium-term net interest income compression with incoming rate cuts, partially offset by reduced funding costs and improved credit conditions.
Going forward, inflation is expected to decline from 3.8% as goods disinflation continues and services inflation gradually cools. This environment may enable the BoE to initiate rate cuts. Key indicators for traders are services CPI, pay growth, and front-end gilt pricing, as these will influence UK assets into the year-end. A clear reduction in services CPI may open the possibility for a December rate cut, while persistent inflation could delay the first cut until 2026.
For more information, please refer to Daniela Hathorn , Senior Market Analyst at Capital.com.
Based on reporting by TechBullion.