The Bank of England expect inflation to peak at 10% in Q3.

As recently as last summer, when talk of inflation pressures were starting to be foreseen and raised as a concern, the Bank of England was inactive on rate rises. The Government had also not wanted to raise rates as that would mean higher mortgage costs for some and that the servicing cost of the UK national debt will increase. For evert 1% rise in UK interest rates the UK national debt interest payments go up by £20.8bn per year.

The BoE started raising rates in December and again in February and March, each time by 0.25%. The Governor of the Bank of England, Andrew Bailey has now warned of higher inflation and a shrinking economy to come. Six members of the MPC voted for a 0.25% rate rise while 3 voted for a 0.5% rise. All agreed that further tightening is needed, meaning we can expect higher borrowing costs along with general price rises. Markets are now expecting UK interest rates to hit 2.25% to 2.5% by the end of 2022. This is higher than previously expected.

The BoE announced a 0.25% interest rate rise one day after the Fed announced their 0.5% hike. As a result, sterling fell against the dollar from US$1.26 to US$1.23. The pound is now 9% down on the dollar since January. Just like the Fed, the BoE set out a disappointing economic forecast and an expectation of further rate rises to come. Markets are now expecting a further 5 interest rate rises over the next twelve months.

The BoE has predicted that UK growth will be 3.75% this year and -0.25% next year. They expect inflation to hit 9% in Q2 and 10% in Q3 when the Ofgem energy cap is renewed, but fall back to 7% in Q1 2023. The BoE then expect inflation to be back to under 2% in 2024.

The cost-of-living crisis is impacting these forecasts. Price rises will eat into household income and cut business profits with consumers starting to reduce their spending. The BoE predict that household spending growth will fall from 4.75% in 2021 to 1% growth in 2022. The slowing UK economy is expected to shed jobs and the unemployment rate rise from 3.85% now to 5.5% over the next 3 years. When unemployment starts to rise will be a signal to stop rate rises.

Families on low incomes will be most exposed to rising prices and interest rate hikes as they are least likely to have savings to fall back on. The government is under pressure to do more to help families through this inflation spike.

Andrew Bailey has called for a covid vaccine like approach to make sure the UK is ready for the winter. He believes that the UK must focus upon resilient energy supply including new sources of energy and in particular LNG.

Fund managers are expecting fading inflation as the cost-of-living crisis hits spending. Today’s outlook for inflation suggests that bond yields will keep raising for a period. This could favour the cheaper value style stocks over the more expensive growth stocks. That said growth companies with high quality, profitable and inflation resistant businesses are still attractive.

While the future is uncertain and when economic growth weak and inflation high, it is the large cap defensive stock in the pharmaceutical, energy, supermarkets, commodities and industrial sectors that have done well and able to pass on rising costs.

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