San Francisco Frontiers - Bank of England to hike again over stubborn inflation

The British central bank's Monetary Policy Committee (MPC) had been expected to raise its key lending rate, which stands at 4.50 percent, by another quarter-point to combat inflation that is the highest among G7 nations.

However, bombshell data out Wednesday showed UK inflation holding at 8.7 percent in May, dashing hopes of a slowdown and sparking bets on a larger half-point hike.

Either move would bring the BoE rate to the highest level since the 2008 financial crisis and further dent economic activity.

A hike would be in stark contrast to the Federal Reserve which paused last week after a sharp easing in US inflation, but would outpace the European Central Bank's quarter-point increase.

Norway and Switzerland are also expected to lift borrowing costs on Thursday.

- 'More work to do' -

"The bottom line, regardless of the size of tomorrow's move, is that the MPC has a lot more work to do to bring underlying (UK) inflation under control," said BNP Paribas analysts.

Wednesday's data dealt a major blow to British Prime Minister Rishi Sunak, who has made slashing inflation a priority for his Conservative government heading into a general election next year.

UK core inflation, which strips out food and energy costs, spiked in May to 7.1 percent -- the highest in more than three decades.

Sunak now faces a burgeoning crisis in Britain's housing market, with mortgage rates and rents surging, biting deep into disposable incomes while pay rises fail to keep pace with inflation.

Traders now anticipate UK interest rates will hit six percent by the end of the year, while the Fed will likely stand pat and the ECB could soon reach the top of its current rate-hiking cycle.

JP Morgan economist Karen Ward, who sits on Hunt's economy advisory council, warned that the BoE might have to effectively "create a recession" if it is to bring inflation under control.

- 'Biggest concern' -

The British government wants to see inflation reduced to five percent by the end of the year, or about half the level at the start of 2023.

"Inflation is what erodes people's savings and pushes up prices, and ultimately makes them poorer," Sunak said Wednesday.

But main opposition leader Keir Starmer, whose Labour party is well ahead of the Conservatives in opinion polls, slammed Sunak over the "Tory mortgage penalty" as home loan rates continue to climb.

The BoE has lifted rates from a record-low 0.1 percent in late 2021 as it sought a handle on inflation, which hit a 41-year peak at 11.1 percent last October on rampant energy bills after gas producer Russia invaded Ukraine.

The policy has sent the UK government's long-term borrowing costs -- used as a reference for mortgage products -- jumping.

Commercial lenders also tend to match the BoE's rate moves on their home loan products, which are typically offered for two or five years but are renegotiated upon expiry.

"The biggest concern now will be the steeply rising mortgage rates," warned Richard Flax, chief investment officer at wealth manager Moneyfarm.

"The added premium on mortgages, along with the cost-of-living squeeze from inflation, will add significant duress on many households."

D.Parker--SFF