Inflation rose unexpectedly to 3% in January after having dropped closer to the Bank of England’s (BoE) target at 2.5% the month prior.
This resurgence was mostly driven by the introduction of VAT on private school fees and high transport costs, particularly on air fares – prices in this sector rose 1.7% in January after falling 0.6% in December.
The pressure is now on for the UK economy to deliver growth, according to Neil Birrell, CIO of Premier Miton Investors. Gross domestic product (GDP) rose 0.4% in December, beating expectations but still only amounted to a 0.1% uplift over the quarter.
“There is cause for concern, although the one bit of good news is that core inflation was no worse than thought,” Birrell said. “While the economy did post a positive growth number in the final quarter of last year, there must be some doubt as to whether it is growing today.
“A stagnant economy, with sticky inflation is not what the government or BoE want to see, but policy measures to easily sort the problem will be hard to come by.”
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Weaker economic growth will make future monetary changes more difficult for the BoE, who cut interest rates by 25bps to 4.5% earlier this month in what Richard Carter, head of fixed interest research at Quilter Cheviot, called “an effort to boost what had been a flatlining economy”.
“While the surprise uptick in December will have been welcomed, the outlook is still concerning and forecasts for the year ahead have been slashed,” he said.
“Growth will remain at the top of the Bank’s agenda, and it will no doubt be hoping that its latest rate cut will start to stimulate the economy. However, it will take some time to feed through so we can expect a relatively sluggish start to the year in the meantime.
“Should the spike in inflation peak at a level above expectations, or if the increase is too prolonged, then the Bank could find itself with a nasty headache. ‘Stagflation’ is a word that will have haunted the BoE in recent years, and we could see a resurgence in the coming months should the UK economy not respond as hoped.”
However, while GDP growth remains a top priority, JP Morgan global market strategist Zara Nokes said it is employment figures that will “raise alarm bells” for the BoE.
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The Office for National Statistics (ONS) revealed yesterday that regular pay excluding bonuses rose by 5.9% in December while unemployment remained static 4.4%.
The hikes in employers’ national insurance contributions may reverse this when it comes into effect in April, but could remain an upward driver to UK inflation until then.
Nokes said: “Some members of the Monetary Policy Committee have expressed concerns around growth weakness but, in my view, any slowing in the labour market will likely be limited as firms are compelled to hoard workers amid ongoing labour shortages.
“The Bank should, therefore, place greater weight on the upside inflation risks as opposed to any moderate cooling in economic activity. If the Bank decides to take its foot off the brake too quickly, it would be far more painful to re-anchor inflation expectations further down the line.”
This story was written by our sister title, Portfolio Adviser
