BANK OF ENGLAND’S FIGHT AGAINST INFLATION IS MADE HARDER BY BETTER CONSUMER SENTIMENT

BANK OF ENGLAND’S FIGHT AGAINST INFLATION IS MADE HARDER BY BETTER CONSUMER SENTIMENT

This week we saw the Bank of England make a big effort to try and get on top of inflation. The bank has been repeatedly caught out by inflation that has risen far higher and lasted far longer than predicted. It appears that the bank has finally realised that the UK’s inflation problem is much more severe than in other advanced economies. This week’s 0.5% hike was larger than expected but the market reaction was fairly calm.

The UK’s problems are illustrated by this morning’s news as consumer confidence is improving and activity in the services sector continues to grow (it was services spending that largely accounted for the higher inflation reading this week). Retail spending is also on the rise. Governor Andrew Bailey made it clear that rising rates will hit household finances, particularly through rising mortgage costs. However, the number of people on fixed-term mortgages means the impact of higher borrowing costs will be staggered and it will take time for rate hikes to take full effect. In the meantime, the risk has increased that the Bank will go too far in its efforts to regain the initiative and try and restore its credibility.

UK: BANK OPTS FOR BIGGER HIKE AS INFLATION REMAINS UNCHANGED

The Bank of England increased base rate by 0.5% as inflation again proved more resilient. The Monetary Policy Committee was expected to hike rates by 0.25% but opted for a larger hike as the bank said a lack of action now risks making problems worse later on. Headline inflation in May was unchanged at 8.7%. Meanwhile core inflation (excluding changeable food and energy costs) increased to 7.1%. The increase in rates will mean a further rise in mortgage borrowing costs, while rising rates have helped push total government debt above annual GDP for the first time in 60 years.

The Swiss and the Norwegian central banks also hiked rates. Federal Reserve chair Jerome Powell presented a more aggressive case for future rate hikes. Equities fell on the more hawkish approach. Short-dated government bonds fell in value as markets anticipate more rate hikes in the coming months, but longer dated bonds climbed as markets see a greater chance of recession and expect rates to come down early next year.

CHINA: CENTRAL BANK CUTS RATES TO REVIVE CONSUMER DEMAND

The People’s Bank of China cut key lending rates in a further attempt to boost slow growth. The PBoC cut the 1 and 5-Year Loan Prime Rate by 0.1%. The cuts are the first in almost a year as Chinese economic growth has failed to recover as expected after the country’s strict anti-Covid measures were removed. The cut was smaller than expected and some Chinese stocks, including property, fell as a result.

The 5-year rate is the benchmark rate for mortgage borrowing and China’s housing market continues to struggle. Consumer confidence remains low and confidence in the property market is also depressed. Property and construction are crucial for the health of the Chinese economy and the sector accounts for around 25% of annual GDP. Official data shows average house prices falling by 0.1% in May and private sector data shows house prices in the prime market of Shanghai have been falling for the last three months. Goldman Sachs has reduced its forecast for annual GDP growth from 6% to 5.4%.

EQUITIES: RETAILERS EXPERIENCE MIXED FORTUNES FROM INFLATION

Next increased its forecast for profits and said it has benefited from increased disposable income as annual pay reviews were implemented in April. The retailer said warmer weather also helped sales as it raised its forecast for full year profits by £40m to £835m. However, persistent inflation has been bad news for some retailers. Halfords reported full year profits fell from £89.8m in 2022 to £51.5m. It says the higher cost of living caused car tyre sales to fall 14% and sales in its cycling division are down 24% as customers opt for cheaper brands, or cancel big ticket purchases completely.

The value of retail sales is running considerably behind inflation, meaning a decline in the volume of goods sold. Figures from the Office for National Statistics show sales volume in May was down 4.7% on last month. There is positive news as food price inflation appears to have peaked. Research firm Kantar said food inflation fell for the third month in a row (down from 17.2% to 16.5% last month) and Tesco reported prices are falling for more items.