The September PMI data may have swayed the MPC to vote 5-4 in favour of maintaining bank rate at 5.25%. This could be a policy mistake. Politicians had been pressuring the BoE to pause rate increases, and it now appears the central bank has acquiesced to these demands. Sterling has fallen in response. The BoE is at risk of appearing weak, caving into political pressure.
A lot was made of the August CPI report, which surprised to the downside. But it is important to take a step back: headline inflation in the UK is still running at 6.66%. Core inflation (ex-food, energy, alcohol & tobacco) stood at 6.23% in August. Services inflation was even stronger (6.83%). Headline and core (ex-food & energy) CPI inflation in the US remains a lot lower (3.67% and 4.35%, respectively).
The recent upside surprise to the Canadian inflation data underlines the dangers for the UK economy. Canada, Australia, and New Zealand are highly exposed to the rise in mortgage rates, but inflation remains very sticky. Until labour markets loosen materially, inflation will not ease by that much.
The shift in narrative towards fiscal responsibility is helping to support gilts. But the jury is still out. If the BoE has made a policy mistake, gilt yields may well rise again. Bank rate may not have peaked yet. The ‘relief’ from lower mortgage rates will be short-lived. Indeed, real yields are rising sharply in the US. Against this backdrop, the Bank of England will find it hard to prevent real yields from climbing further.
