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Economy: UK Inflation hit 2.1% in May

  • UK inflation jumped 2.1% in May in line with the reopening of the economy
  • UK economy growing faster than Bank of England’s predictions
  • Significant rise in fuel and clothes prices
  • Price rises sparked by consumers rushing back to the UK high street
  • Bank of England warns that high inflation levels should only be temporary
  • British pound (GBP) edges higher against major currency competitors

UK inflation has experienced a recent surge as data reveals significant growth of 2.1% during May 2021. Following a severe economic depreciation resulting from COVID-19, the UK is now seeing price rises for various goods, particularly fuel and clothing.

According to the Office for National Statistics (ONS), the rate of inflation, measured by the Consumer Price Index (CPI), rose from 1.5% in April. Inflation growth levels surpassed predictions from the Bank of England (BoE), which forecast an increase of 1.8% and is now above their 2% target.

The growth surge means UK inflation is now at its peak since before the coronavirus pandemic and is likely to spark a debate as to whether the BoE should increase interest rates. That being said, the Bank is hesitant to impose higher borrowing costs on the UK economy, with the concern that it could diminish the UK’s precarious economic recovery.

UK Inflation hit 2.1% in May

Significant rise in fuel and clothes prices

Chief economist from the ONS, Grant Fitzner, highlighted that UK inflation was last above 2% during summer 2019. He commented that the rise in inflation was largely down to advances in fuel and clothing prices.

The ONS outlined that motor fuels have seen a 17.9% increase over the past year, which is the most notable rise in over four years. Average petrol prices were 127.2 pence per litre in May 2021, compared to 106.2 pence per litre the previous year.

Clothing prices saw a 2.3% surge, which is the steepest increase since 2018, with many stores discounting prices one month after the reopening of the UK high street. During May 2020, the quantity of discounted clothing was moderately high due to the first coronavirus lockdown in March 2021. This period saw reduced consumer demand, with more people forced to remain home, negating the need for new clothing. Instead, we saw a shift towards other home essentials such as food and cleaning products.

There has also been a significant acceleration in UK producer prices, soaring 4.6% year-on-year in May 2020, increasing from 4% in April. Input costs also rose by 10.7% on the year, which is the most substantial level since September 2011. The price rise was led by costly metals and crude oil costs, such as copper and oil, which has surged to a pre-pandemic high.

Demand for downloadable computer games has also seen a dramatic surge over recent months, with prices rising 2.8% in May. Meanwhile, demand for construction toys such as Lego has taken a plunge after proving popular during the first coronavirus lockdown.

Other prominent price increases up from last year outlined in the UK inflation report include alcohol and tobacco (up 1.7%), housing, water and electricity (up 1.9%), household equipment (up 2.8%), transport (up 6.5%), restaurants and hotels (up 1.8%).

The recent inflation increase was partially offset by the impact of inexpensive food and drink prices. The price of products such as bread and cereals had taken a hit after seeing substantial increases in 2020.

Consumers rushing back to UK high street

Since being ordered to shut up shop by the UK government in January due to rising coronavirus cases, consumers are now flooding back to the high street. Non-essential stores were permitted to reopen in April 2021 as part of UK Prime Minister Boris Johnson’s exit roadmap strategy out of lockdown.

The pent-up demand during the latest coronavirus lockdown has led to a rapid increase in retail sales. Karen Ward, chief market strategist at JP Morgan Asset Management, labelled May’s inflation reading a surprise. Ms Ward noted that UK consumers had saved significant amounts of money during lockdown, and the supply of goods is struggling to keep up with demand, leading to ‘pops of prices’ in various consumer items. There is concern that if the same level of inflation pressures continue into 2022, we will likely see interest rate hikes.

Yael Selfin, chief economist at KPMG UK, suggests that inflation could rise further due to staff shortages in industries such as hospitality, as employers will likely increase wages to retain workers. However, Ian Stewart, chief economist at Deloitte, highlighted that with over three million people currently on furlough in the UK and unemployment above pre-pandemic levels, a rise in wages appears unlikely, though it is not an impossibility.

Ms Selfin further stated that the BoE is likely to refrain from boosting interest rates in the near term as prices currently remain uncertain and are forecast to ease in 2022, stabilising the Bank’s 2% target. As a result, the BoE will likely delay interest rate rises to 2023. For now, UK interest rates remain at record lows at 0.1%.

Bank of England warn that high levels of inflation should be avoided

The BoE’s chief economist, Andy Haldane, stated that a rise in inflation over the Bank’s 2% target is only a cause for concern if it remains long-term, warning that high inflation levels should be avoided at all costs.

BoE governor, Andrew Bailey, reassured that it is typical to experience a spike in inflation following an ‘unprecedented shock’ and that costs often settle when consumer activity returns to normal.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, forecasts that UK inflation will peak at 2.8% in 2021 and will slowly return to the Bank’s 2% target during mid-2022. This prediction is slightly under the forecast from Capital Economics, which now believes CPI will hit 2.9% in November, up from their previous forecast of 2.6%.

The United States is also experiencing rising inflation, hitting 5% in May, the highest level in nearly 13 years. Jack Leslie, an economist at the Resolution Foundation, highlighted that UK inflation levels are very different from that in the US and are not as large and impactful.

The topic of inflation will be high on the Federal Reserve agenda during today’s monetary policy meeting. There is the potential that the US could slow down its bond-buying stimulus programme due to recent price rises. However, Fed Chair Jerome Powell is likely to maintain a dovish tone, holding the view that the current high inflation is merely transitionary.

If the Federal Open Market Committee (FOMC) proceeds as expected, it’s thought that this could drive the British pound (GBP) and euro (EUR) higher. The Fed’s ‘lower for longer’ interest rate outlook is likely to limit US dollar (USD) gains in the near term.

Inflation figures underpin the British pound (GBP)

The British pound (GBP) has struggled to advance against its major currency competitors over recent weeks. However, today’s UK inflation data appears to be providing support for Sterling. The British pound to euro (GBP/EUR) exchange rate rose to EUR 1.1625 this morning, and the British pound to US dollar exchange rate currently stands at USD 1.41, having slumped to a two-month low yesterday of 1.4033.

Lee Hardman, Currency Analyst at MUFG, stated that the British pound (GBP) looks to maintain a bullish tone for the foreseeable future. It’s thought that the UK Prime Minister Boris Johnson’s four-week delay on the full lifting of UK restrictions is unlikely to have a significant impact on pound Sterling (GBP) despite its initial reaction.

The UK Government was due to lift all UK coronavirus restrictions on 21st June. However, it was announced last Monday there would be a delay to the 21st June final stage of lockdown due to the rise of the Delta variant.

The British pound (GBP) also took a hit at the start of the trading week due to post-Brexit concerns following news that Irish imports from the UK fell by more than 20% year-on-year in April. UK relations with the European Union (EU) continue to be pressured by discussions concerning a solution with the Northern Ireland protocol. The ongoing negotiations are likely to limit British pound (GBP) gains against the euro (EUR).

Meanwhile, the FTSE 100 reached its highest level since February 2020 at 7217 points, which is a rise of 45 points/0.6%. The peak, however, was short-lived and soon pulled back from the 16-month high this morning.

The biggest riser was distribution and outsourcing company Bunzl who experienced a 2.2% increase. Other rises included B&M (1.6%), Sainsbury’s (1.3%) and Kingfisher (1.2%).

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