FTSE 100 tumbles as UK inflation rate doubled for April

• UK inflation rate more than doubled month-on-month in April
• Investors fear that the post-lockdown spending splurge will lift inflation higher
• Bank of England (BoE) expects rising inflation to be transitory
• Pound Sterling (GBP) vulnerable to higher inflation rates

According to the Office for National Statistics (ONS), UK inflation more than doubled in April, fuelling speculation that the Bank of England (BoE) will begin tightening policy to prevent consumer prices spiralling.

Data released by the ONS revealed that consumer prices surged by 1.5% in April after recording a 0.7% gain in March, driven by a jump in domestic energy and clothing prices.

Last month, all non-essential stores could reopen under the second phase of UK Prime Minister Boris Johnson’s lockdown exit roadmap, which triggered a rapid increase in sales.

The April reading was primarily in step with economist expectations, with a Reuters poll of economists predicting a rise of 1.4%.

UK core inflation, which excludes the volatile categories of energy prices, food, alcohol and tobacco, jumped by 1.3% year-on-year in April. The ONS report also showed that:

• Gas and electricity prices increased by 9.1% in April
• Motor fuel recorded the most significant annual increase since March 2017
• Water supply and sewerage collection jumped by 2.5% and 1.0%, respectively
• Clothing and footwear prices rose by 2.4%, compared to last year’s 1.5% decline
• Food prices climbed 0.9% higher between March and April

Concerns about rising inflation have been mounting since last week’s release of US Consumer Price Index (CPI) data for April, which grew at its fastest pace since 2009.

Although central banks, including the Federal Reserve (Fed) and the Bank of England (BoE), view the increase in consumer prices as “transitory”, investors fear that post-lockdown spending could drive inflation significantly above targets.

The BoE said it is prepared to tolerate a rise in inflation and doesn’t intend to act unless consumer prices rocket or the CPI emerges above the 2% target for a sustained period.

In a statement to the House of Lords on Tuesday, BoE Governor Andrew Bailey implied rising commodity-based costs had caused inflationary pressures. 

“We see these base effects as temporary and don’t believe the momentum will continue forwards at that pace at all,” said Governor Bailey.

BoE attempts to calm inflation fears

The BoE sees UK inflation exceeding the central bank’s 2% target and hitting 2.5% in 2021 due to the surge in commodity prices and extensions to emergency coronavirus aid, which has led to an increase in household savings over the past few months.

However, most policymakers believe that these price gains are temporary and that UK CPI will return to 2% in 2022 and 2023.

But investors fear that the UK’s robust recovery and accompanying inflationary pressures will force the BoE to raise interest rates in 2022, which could lead to a prolonged period of stock market volatility.

Outgoing BoE Chief Economist Andy Haldane already warned that failure to take decisive action could let “the inflation genie out the bottle”, adding that it is “notoriously difficult to get back in.” 

During the May policy meeting, Mr Haldane cast a dissenting 8-1 vote to tighten stimulus and reduce the central bank’s quantitative easing programme from GBP 875BN to GBP 825BN.

The BOE plans to inject a further GBP 150BN into buying government bonds this year. However, given that today’s data has shown a sharp jump in prices and stoked fears about runaway inflation, the central bank may be forced to reconsider stimulus measures.

UK inflation data ignites fears of global runaway inflation

European stocks opened sharply lower on Wednesday after the ONS published UK inflation data.

While the figure fell in line with economist expectations and remains below the Bank of England’s 2% target, the sharp month-on-month increase has raised concerns about UK CPI spiralling as the economy reopens.

AJ Bell Financial Analysts Laith Khalaf said: “Currently, UK CPI is nothing to fret about, but there is growing concern that the fiscal and monetary response to COVID-19 has sown the seeds of an inflationary scare further down the road.

“That, combined with already inflated valuations in parts of the stock market, means investors in shares should expect some volatility in the months ahead.”

UK inflation data has sent global shares tumbling by their steepest margin in three months today, with investors questioning whether record-high commodity prices and inflationary pressure are merely transitory.

After closing at 15,386.58, Europe’s DAX Performance Index is down by 1.26% or 193.62 points at 15,192.96 during midday trade on Wednesday.

US markets also closed in the red in overnight trade, and futures point towards a lower opening. Wall Street’s S&P 500 Index closed 0.85% or 35.46 points lower at 4,127.83, while the tech-heavy Nasdaq Composite was down by 0.56% or 75.41 points at 13,303.64.

Asia has seen mixed trade on Wednesday, but Japan’s Nikkei 225 share average has dropped by 1.28% to close at 28,044.45, while China’s Shanghai Composite Index slipped by 0.51% to 3,510.96.

UK stocks are also suffering, with London’s blue-chip FTSE 100 Index down by more than 1% in midday trade at 6,946.65 and the FTSE 250, 0.62% or 139.45 points lower at 22,193.11.

Pound Sterling (GBP) has also been affected by UK CPI figures and is trading 0.2% lower against the US dollar (USD) and flat against the euro (EUR).

Although rising consumer prices tend to have little impact on the British pound (GBP), the currency is vulnerable to higher levels of sustained inflation.

British pound vulnerable to higher inflation

Just as pound Sterling (GBP) was attempting to push the upper limits of its long-term range against the US dollar (USD), today’s CPI data from the ONS has dampened demand for the currency.

While inflation fears have fuelled a rise in pound Sterling (GBP) exchange rates, confirmation of higher inflation would more than likely force BoE policymakers to tighten policy, which poses downside risks for the economy, and in turn, GBP.

As today’s data fell in line with economist expectations, there appears to have been some disappointment among GBP bulls, which has prevented a significant directional shift for the currency.

However, pound Sterling (GBP) has edged lower against risk-off currency rivals such as the US dollar (USD), which suggest that investors are becoming wary and beginning to pile into safe-haven currencies.

That view could be reinforced by the British pound’s (GBP) gains against riskier trading partners such as the New Zealand dollar (NZD) and the Australian dollar (AUD).

Economists at Berenberg Bank believe that financial markets are right to pay attention to inflation and predict a “great inflation reset” for the global economy due to the impact of COVID-19.

Berenberg Bank’s senior economist, Kallum Pickering, says that “structural factors such as ageing populations, continued deglobalisation in goods trade and further fiscal activism reinforces this inflationary dynamic.”

Berenberg Bank does not believe that rising prices are temporary and expects UK inflation to hit as much as 3% by 2025 – a development that would place significant pressure on the BoE to raise interest rates.