Temporary breach of 3% triggers inflation ‘apology’

A breach of 3% in UK inflation has triggered a letter of explanation from Bank of England (BoE) Governor Mark Carney to Chancellor Phillip Hammond, and lots of media attention. Consumers will be understandably concerned, especially with wage growth lagging, but we believe inflation will peak soon, and remain well anchored longer term (see our latest investment report).  

Since the Brexit referendum in the summer of 2016, the annual rate of inflation in the UK has been rising steadily. One of the main causes is the dramatic fall in the value of the pound, which has pushed up the cost of imports. Indeed, domestically generated inflation may have already peaked in the first quarter of this year, and if it weren’t for British Gas pushing up their prices and airfares staying unseasonably high, headline consumer price inflation would likely have peaked in September. Core inflation, which excludes food and energy prices, remained unchanged at 2.7%. 

Indicators suggest inflation is peaking

Source: Datastream and Rathbones

Few and far between
Having raised interest rates by a quarter point to 0.5% at its November meeting to ensure inflation remains anchored around its 2.0% target, the BoE was clear to point out than any further rate rises were likely to be few and far between. We would agree, and believe the bank will be more concerned about supporting growth than what we see as temporarily high inflation.

In recent months, sterling has been relatively steady – though still at very low levels historically – alleviating a major cause of recent inflationary pressures. Our framework for assessing how exchange rates trade relative to long-term economic fundamentals suggests sterling has never been so undervalued over the last 36 years. While further weakness in the short term can’t be ruled out, especially given remaining Brexit uncertainties, this is unlikely to be a significant contributor to inflationary pressures from here.

Sterling is at its most undervalued in 36 years

Source: Datastream and Rathbones

What matters in the long run
Over the longer term, the prices we pay for goods and services are influenced by many different forces. To determine how inflation might impact the real value of your wealth, the Rathbones research team have explored the three main forces we believe are likely to drive prices over the next 20 years — demographics, globalisation and employment trends. We have also explored the different investment and asset allocation strategies that could work best under different inflation environments.

Visit our inflation hub for more
You can read about the economic themes driving inflation in greater detail in our investment report Under pressure?, and try our personal inflation calculator on our dedicated inflation hub.

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