UK inflation sucker-punches the BoE, while sterling bulls cheer

LONDON: Bank of England policymakers will not have looked at Wednesday's inflation data with the same enthusiasm as sterling traders, who took advantage of a shock jump to push the pound up, confident that a rate hike this week is now a done deal.

British inflation unexpectedly rose to 10.4 percent in February, pushed up by higher food and drink prices in pubs and restaurants, according to official data which is likely to prompt the Bank of England to raise interest rates on Thursday.

The figures - including increases in underlying inflation measures that the BoE closely monitors - are likely to bolster the concerns of those BoE policymakers who worry that inflation will be slow to fall, even after 10 straight rate hikes.

Markets now see a near 100 percent chance of the BoE raising rates to 4.25 percent from 4.0 percent, firming from a roughly 50/50 chance earlier this week of policymakers doing nothing in light of the crisis of confidence that has rocked the global banking sector.

Investors had been split on whether the central bank would pause that run after the recent upheaval in the global banking sector. But financial markets on Wednesday fully priced in a quarter-point increase to 4.25 percent.

"While the decision has at times over the last week looked to be on a knife edge, this inflation outturn would appear to swing it in favour of a 25-basis-point hike," said Liz Martins, senior economist at HSBC. The rally in sterling, last up 0.45 at $1.227, and a 25 basis point jump in two-year government bond yields were further signs that investors now expect an imminent hike.

While a fall in energy prices is positive in the longer run, prices elsewhere have risen. The problem, said Ben Nicholl, a fund manager at Royal London Asset Management, is "inflation in all the wrong places".

Core inflation, which strips out food and energy, rose by 6.2 percent in February, far above the median forecast of an easing to 5.7 percent in the Reuters poll.

"Core CPI missed by 0.5 percent - that's one of the biggest, if not the biggest misses on CPI in the recent series of inflation data. So it's a shocker for the Bank of England, particularly given they've been so dovish in their recent messaging," Nicholl said.

The cost of food and non-alcoholic drinks rose 18.0 percent - the most in more than 45 years, while the 12.1 percent annual rise in inflation at restaurants and hotels was the biggest since 1991, according to Japanese bank Nomura.

Britain has had the highest inflation among Group of Seven nations with persistent price pressures affecting longer-lasting components such as services and wage growth.

"The UK will be obliged to continue to hike rates," Francois Savary, chief investment officer at Prime Partners, said. "They are in the worst situation you can find among developed economies. The UK has a significant inflation issue and growth has not returned to pre-pandemic levels," he said.