Sticky UK inflation forces BoE to hike once again and supports the GBP (Daily analysis 24.05.2023)

In April, UK inflation clawed back to single-digit figures for the first time since August 2022. Nonetheless, recent readings came in as a very negative surprise. Consumer prices were 8.7% higher in April than a year earlier. Forecasts called for much faster disinflation and a fall in the CPI from 10.1 to 8.2% y/y. Prices rose by as much as 1.2% compared to March, making the third strongest jump since Russia's invasion of Ukraine. This time, however, it is not energy or fuel prices that are to blame, but the core inflation. It unexpectedly skyrocketed from 6.2 to 6.8% y/y, thus reaching a new cyclical peak.

Persistent price pressures combined with better-than-feared growth have forced the Bank of England to extend the interest rate hike cycle. In May, the main rate was hiked to 4.5%. The market pricing points to a continuation of tightening in June, and another 25bp move is mulled through. The monetary authorities' forecasts of inflation falling below 4% in the second half of the year may prove to be too optimistic.

Stubborn price pressures and a prolonged tightening cycle continue to support the pound, which has been the strongest of the major currencies this year. The GBP has gained 2.3% against the euro and around 3% against the US dollar. However, we expect that once rate hikes are finalized, the structural weaknesses of the UK economy, which is the only one in the G7 not yet to have recovered from the pandemic slump, should start to come to the fore. The real estate market and household budgets will be under particularly strong pressure from the highest interest rates since 2008. The adverse effects of Brexit should also become increasingly evident. As a result, we remain negative towards the GBP and expect the EUR/GBP rate to reach 0.90 before the end of the year.