Why Hot Inflation is No Help for the Pound

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The Pound fell on the day the UK announced inflation rose more than expected in the previous month.

The British Pound extended a run of losses against the Euro, Dollar and other major currencies following the release of hotter-than-expected inflation data.

UK Consumer Price Inflation edged higher in June, with headline CPI rising to 3.6% year-on-year said the ONS, up from 3.4% in May, and beating expectations for a repeat print of 3.4%.

The annual CPI services inflation rate, which is particularly important for the Bank of England, remained unchanged at 4.7%, suggesting sticky underlying pressures in the sector. On a monthly basis, services prices rose by 0.6%, matching May’s increase.

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The core CPI rate, which excludes energy, food, alcohol, and tobacco, rose to 3.7% from 3.5% in May. This represents another beat on expectations, where a repeat of 3.5% was anticipated.

CPI goods inflation accelerated to 2.4% from 2.0%, marking the highest goods inflation since October 2023.

Usually, above-consensus inflation numbers would boost the Pound as they imply the Bank of England has less scope to lower interest rates. However, the Pound to Euro exchange rate jumped in knee-jerk style to 1.1537 before sliding back to 1.1525. The Pound to Dollar exchange rate rose to 1.3410.

"These data are unsupportive of the Pound as they suggest the UK is entering a period of stagflation," says Russell Gous, Editor-In-Chief of TopMoneyCompare.co.uk.

Stagflation is where the economy stagnates and inflation rises, creating a poor outcome for consumers, businesses and investors alike. It is damaging to a currency's fundamentals.

UK inflation is rising again, but the Bank of England holds the view that it will fall sharply next year.

“Dare we say it, but Britain is now stuck squarely in stagflation. The economy is contracting, jobs are being shed at a breakneck pace and, all the while, inflation is rising without any signs of having yet peaked," says Matthew Ryan, Head of Market Strategy at Ebury.

Given the stagnation in the UK economy and falling employment, the Bank of England would like to accelerate the pace at which it cuts interest rates, which it thinks will offer a buffer.

But inflation is the limiter to these ambitions: it is hard for the Bank of England to justify further rate cuts given the trends in the data we are seeing. Cutting interest rates further will risk exacerbating inflationary pressures for longer.

These inflation data therefore push back somewhat on rising bets for a further three rate cuts in 2025, which will in turn raise short-term bond yields.

The problem for the Bank of England is that price rises are broadly spread, meaning we are not watching a 'flash in the pan' for prices.

According to the ONS, transport prices were a key contributor to the rise in headline CPI, reflecting smaller declines in fuel prices and a sharp increase in airfares. Clothing and footwear prices also rebounded, posting a 0.5% annual increase after falling 0.3% the previous month.

Meanwhile, housing and household services inflation eased slightly to 7.5%, down from 7.7% in May, providing a partial offset to the overall price pressures.

"The surprising strength of the inflation figures adds additional issues to the UK’s mounting economic woes. All eyes will turn to the Bank of England who have indicated they are willing to cut rates given the cooling in the jobs market but are unlikely to be able to justify a cut when inflation has started to run hot once again," says Isaac Stell, Investment Manager at Wealth Club.

"This presents a major quandary for the Bank of England. Does the MPC cut rates now in the hope that inflation eases later in the year? Or does it hold off for fear of further stoking price pressures? We still think that an August cut is on the cards, but today’s data means further rate reductions beyond then will likely be very gradual,” says Ryan.