UK inflation surges to 2.1% as economy reopens

Soaring fuel and clothing costs helped drive up prices in May

FILE PHOTO: People shop in the Selfridges department store on Oxford street, as the coronavirus disease (COVID-19) restrictions ease, in London, Britain April 12, 2021. REUTERS/Henry Nicholls/File Photo  GLOBAL BUSINESS WEEK AHEAD
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UK inflation jumped to 2.1 per cent in May, its highest level since before the pandemic, as much of the economy reopened from lockdown.

A surge in fuel costs and rising clothing prices helped drive the Consumer Price Index to 2.1 per cent in May, the highest since July 2019, up from 0.5 per cent year-on-year and from the 1.5 per cent recorded in April.

Inflation is now above the Bank of England’s 2 per cent target in a major surprise for analysts who were expecting a more modest increase of 1.8 per cent.

“Another sharp spike in inflation, which is now running at a two-year high, was inevitable as the government released the shackles from Britain’s lockdown economy," said Ben Laidler, global markets strategist at multi-asset investment platform eToro.

Motor fuels surged 17.9 per cent over the past 12 months, their biggest increase for more than four years, the ONS said, while clothing prices rose 2.3 per cent, the biggest jump since 2018, as retailers scaled back discounting in the month after customers returned to shops.

“Price increases by reopening service suppliers were one of the key drivers behind the rise, such businesses no doubt looking to exploit the much talked about pent-up demand and attempt to recover losses incurred over the course of the pandemic,” said Stuart Cole, chief macroeconomist at brokerage Equiti Capital.

With stage three of Prime Minister Boris Johnson's road map taking place on May 17, allowing indoor dining and cinemas, museums and theatres to reopen, still to feed into the figures, Mr Cole expects upward pressure on prices from the services sector in June.

“However, some of the rise was also the result of an unwinding of falls seen previously, suggesting that overall, the pace of increases going forward should slow,” he said.

Mr Laidler said the fact that annual inflation was now running at or above the BoE’s 2 per cent target for the first time in two-and-a-half years would spook some investors, who would no doubt see soaring prices as a sign that a rate rise was nearing.

“However, we are not at that point yet,” he said. “The Bank of England has stated a number of times that it sees the most recent bout of inflation as transitory or, in other words, temporary. Wages are set to grow slower than prices and therefore this will act as a natural cap on inflation in the coming months.”

The immediate market reaction suggested investors supported the BoE’s view that the inflation gain would be temporary. The pound rose 0.3 per cent against the dollar in early trading and the yield on benchmark 10-year gilts gained fractionally.

BoE chief economist Andy Haldane, who departs his post at the end of this month, said last week that pay and costs were already rising and high street inflation “can’t be far behind”.

BoE governor Andrew Bailey said this week that the UK was entering a period of higher inflation and while he expected it to be temporary, it would need to be tracked.

Mr Cole said the BoE's stance was unlikely to change on the back of today’s numbers with rising prices continuing to be viewed as transitory, "as labour market slack provides a buffer to growing inflationary pressures”.

This pressure is will be boosted by the end of the government's furlough scheme for jobs at the end of September, with the Monetary Policy Committee likely to expect sterling’s appreciation this year to start bearing down on headline CPI in the second half of the year.

However, recent comments from some MPC members suggested concerns were starting to seep into the MPC’s thinking "regarding just how strong these downward pressures might turn out to be".

“If employment levels hold up as the furlough scheme ends, then we could start to see the MPC’s message become increasingly less dovish," Mr Cole said.