Sterling retreats as UK inflation hits new 40-year high

By Danilo Masoni

LONDON (Reuters) – The British pound pulled back on Wednesday after data showing UK consumer inflation hit a new 40-year high raised fresh worries over an economic slowdown, just as the Bank of England looks set for more interest rate hikes in the coming months.

Soaring food prices pushed consumer inflation to 9.1% in May, the highest rate in the Group of Seven countries and underlining the severity of the cost-of-living crunch in the world’s fifth-largest economy.

The figure was in line with market expectations and following its release money markets continued to fully price in a 25 basis point (bps) BoE rate hike in August. The odds of a 50 bps hike slimmed to just above 60% from around 74%, even though analysts said a such a move was still on the cards.

“The latest temperature check of the UK economy shows the mercury rising again, with no end yet in sight to the feverish pace of price rises,” said Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.

“The Bank of England has already forecast that inflation will hit 11% by the autumn, and it’s steadily creeping towards that ugly marker sooner rather than later,” she added.

Sterling fell against a stronger U.S. dollar but came off near one-week lows hit shortly after the data. By 0927 GMT it was down 0.4% at $1.223 following two days of gains. Versus the euro, the pound fell 0.2% to 85.96 pence.

“The reaction among currency traders was to send sterling lower, as investors fret that rising prices could trigger a slowdown in UK growth during the rest of the year,” said Matthew Ryan, head of market strategy at Ebury.

“Conversely, we think that the data may end up being bullish for sterling should it encourage the Bank of England to raise interest rates more aggressively,” he added.

The BoE raised its benchmark rate by 25 bps to 1.25% last Thursday and said it was ready to act “forcefully” if needed to stamp out dangers posed by inflation, although that lagged stronger action from other central banks including the U.S. Federal Reserve.

ING said it saw scope for a 50 bps BoE rate hike in August.

“UK inflation remains above 9% and the recent rise in energy costs will probably help the headline rate go slightly into double-digits from October,” said ING economist James Smith.

“The chances of a 50bp Bank of England rate hike in August are rising, though we think there’s only so much further it can hike in the current fragile growth environment,” he added.

Traders were also keeping an eye out for two by-elections on Thursday: one in Tiverton and Honiton and another in Wakefield in northern England.

Defeat in either place may further dent Prime Minister Boris Johnson’s vote-winning reputation, and see lawmakers who fear for their futures try to move against him despite giving him a reprieve by calling and losing a confidence vote against him earlier this month.

Concerns over the British economy and the slower pace at which the BoE is expected to tighten policy compared to other central banks have made investors bearish on the pound.

The net short position now stands at $4.8 billion, but has fallen from a peak hit in May of $6.3 billion, the largest short since September 2019.

(Reporting by Saikat Chatterjee, Danilo Masoni, Anisha Sircar and Samuel Indyk, Editing by Andrew Heavens and Kim Coghill)