The Bank of England may have to raise the rates again as U.K. inflation is likely not slowing fast enough

• Contrary to market’s expectations, the UK headline inflation rate probably accelerated in September.
• The Bank of England may have to raise its benchmark interest rate in November.
• The British pound may actually depreciate further if recession risks increase. 

On Wednesday, October 18, at 6:00 am UTC, the U.K. Office for National Statistics (ONS) will publish Inflation and Price indices for September.

The market is expecting the headline Consumer Price Index (CPI) to decline to 6.5% year-over-year (y-o-y) from 6.7% in August. The core CPI is expected to fall to 6% from 6.2% y-o-y. However, some analysts believe that U.K. inflation figures may actually come out higher than expected, prompting the Bank of England (BoE) to raise the rates again.“It will not be a pretty number”, said Octa analyst, referring to the upcoming CPI release and adding that “key price pressures are not going away. If anything, they have strengthened lately due to rising energy costs. Therefore, a higher-than-expected CPI print is certainly on the cards.” 

Indeed, crude oil and natural gas prices were higher in September than they were in August. The average price of Brent crude was up 9%, while the U.K. National Balancing Point (NBP) natural gas price was up almost 4% in September compared to August. Although key energy prices were still lower than a year ago, the fact that they are rising in monthly terms is adding pressure to the underlying measures of inflation.

The upcoming CPI report is hard to overestimate. It is probably the single most important economic data release, on which the BoE bases its monetary policy decisions. Previous report (released on September 20) showed an unexpected decline in the inflation rate and opened up the possibility for the BoE to keep the rates on hold (after 14 increases since December 2021). However, analysts point out that it was probably just a “one-off” report and that inflation is to remain sticky.

“The previous report featured a big downside surprise to core inflation but it was mostly due to base effects. Now we are seeing that the disinflation process is slowing due to rising fuel costs and so an upside surprise to inflation is possible”, said Octa analyst, adding that “the BoE is likely to hike its benchmark interest rate when it meets on November 2”. 

The choice that the Bank of England is facing is not an easy one. “I do not see how BoE can achieve a soft landing for the economy. It is either high inflation or a recession for them. I think they will choose the lesser of two evils and will opt for higher rates and a recession”, said Octa analyst.

In theory, high inflation should have a positive (if short-term) impact on the exchange rate because it raises the likelihood of higher interest rates. Therefore, if the U.K. CPI report does indeed show an uptick in the inflation rate and beats analysts’ estimates, GBPUSD will likely jump sharply. 

“A higher-than-expected CPI print may push the cable towards 1.23000. However, the rally may not last if recession fears overtake investors’ sentiment”, said Octa analyst.  

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