After the UK’s latest inflation figures were higher than forecast last month, investment managers discuss what this means for the economy, potential interest rate rises, investors and mortgage holders.

Latest figures from the UK Office Office for National Statistics show inflation stayed at 8.7 per cent in May from a year ago, higher than the predicted 8.4 per cent. It puts additional pressure on the Bank of England to raise interest rates today.

The figures stop the downward trend in UK inflation, which had been falling after a peak of 11.1 per cent last year. Rising prices for air travel, recreational and cultural goods helped keep inflation high, the ONS said. Nevertheless, food and non-alcoholic beverage food inflation dropped slightly from 19.1 per cent to 18.4 per cent.

Core inflation – which strips out energy and food costs – also rose in May to 7.1 per cent from 6.8 per cent, the highest level since 1992. 

All eyes turn to the BoE and its interest rate-setting committee's deliberations. Markets are pricing in 6 per cent by the end of the year. The BoE is expected to raise rates from 4.5 to 4.75 per cent today to help tackle inflation, with some predicting a 0.5 per cent jump, after Prime Minister Rishi Sunak pledged to half inflation by the end of the year. 

This puts further pressure on mortgage holders, with variable rates likely to go up again and with people on fixed-rate mortgages having to refinance soon. But Chancellor of the Exchequer Jeremy Hunt ruled out this week any major action to bail out homeowners.

Here are some reactions from investment managers to the high inflation levels.

Isabel Albarran, investment officer at Close Brothers Asset Management
“The UK’s tight labour market remains a significant concern, potentially exacerbating the strength in services prices. Labour data has cooled marginally, with the pace of new job openings in decline and redundancies edging higher, but wage growth remains too high for the Bank’s comfort. Inflation is still expected to cool this year, helped in a big way by energy prices and the return to relevance of the Ofgem price cap but, once the easy wins are behind us, employment needs to slow if the BoE is to get inflation sustainably below target.
 
“For investors, higher yields have renewed appetite for fixed income but this trade has had a sting in the tail. We had expected to see continued rate hikes in the UK over the coming months, but markets now expect the Bank rate to continue to increase into next year, and as far as 6 per cent. This has pushed bond prices down and yields back up to “Truss-on omics” crisis levels. Mortgages may provide the bitter antidote to rising interest rate expectations. The greater popularity of fixed rate mortgages today means that the effective interest rate on the average outstanding mortgage was below 3 per cent in May. With 1.3 million households expected to reach the end of their fixed-rate term in the second half of this year, that number is likely to rise sharply, inflicting pain on households and hindering consumption spending and growth. MPC members need to be counting cash-strapped homeowners rather than sheep.”
 
Daniele Antonucci, chief economist and macro strategist, Quintet Private Bank (parent of Brown Shipley)
“The outlook for inflation, with a tight labour market and strong wage growth, is one where price pressures look self-sustaining, in a loop whereby stronger wages lead to stronger inflation which leads to stronger wages and so on. This is likely to pour cold water on hopes that the Bank might be able to at least pause its rate hiking cycle in the near term, just like the Fed did earlier this month.

Rather, looking at the next couple of monetary policy meetings, we think the Bank is likely to continue to tighten financial conditions and squeeze incomes further, with a rate hike again in August and then another one in September.”

Julian Jessop, economics fellow at free market think tank the Institute of Economic Affairs
“Headline inflation should still drop sharply over the rest of the year as food and energy prices fall back. But the problem now is that core inflation, excluding food and energy, is no longer just ‘sticky’. Instead, it is actually heading in the wrong direction. To some extent, this is driven by temporary factors like the extra Bank Holiday and the large increase in the national minimum wage. The bigger picture, however, is that the UK is still paying for the Bank’s underestimation of inflation and decision to keep monetary policy too loose for far too long. The government should avoid kneejerk and counterproductive policies like mortgage subsidies or price controls. But they have a role in tax and regulatory reform, including fixing our broken planning system, to ease constraints on the supply side and to boost the economy’s productive potential."

Gurpreet Gill, macro strategist, global fixed income, Goldman Sachs Asset Management
“Sustained strength in UK inflation in May cements the case for the Bank of England to deliver further tightening at its meeting. While our base case is for a 0.25 per cent rate hike at this week’s meeting, the data opens the door to an increased pace of a 0.5 per cent rate rise. Core and services inflation, alongside food prices, continue to diverge from moderating trends observed in other advanced economies like the US, complicating the path towards the Bank’s target. We see upside risks to our terminal rate forecast of 5.25 per cent. However, downside growth risks may exert disinflationary pressure later this year.”

Luke Bartholomew, senior economist, abrdn
“The UK’s May inflation report is certainly ugly enough to keep the debate live about a 50 bps hike from the Bank of England. While the probability of such a move has increased, we still think a 25 bps move is more likely, especially given the mounting dysfunctionality of the rates and mortgage markets. The importance of the coming period for a large stock of mortgage refinancing means that the Bank risks locking in even more pronounced recessionary forces if it encourages rates markets much higher with a larger increase tomorrow. However, we also think that rates will now need to move above 5 per cent, and now pencil in a terminal rate of 5.25 per cent ahead of the Bank’s decision.”  

Charles Hepworth, investment director, GAM Investments
“Persistent inflation is here and the current administration’s (perhaps rather ambitious) pledge to half inflation by the year end has confronted with a huge sword to fall on.  Pleas from Downing Street to Threadneedle Street to get a handle on inflation, which curiously they seem to have no ability to, despite raising rates at one of the fastest rates in its history will likely increase after this month’s inflation surprise.  A hike tomorrow of 0.25 per cent is all but guaranteed and after today’s numbers it could even be more. The Bank of England finds itself in an unviable position, as hitting consumers with higher rates will slow the economy and push it towards contraction.  Being less hawkish only allows this structural post-Brexit inflation issue to metastasize further. This poses impossible choices for policymakers indeed.”

Charles White Thomson, CEO at Saxo UK 
“The UK inflation print is highly disappointing and is another heavy blow for the beleaguered UK consumer. The UK is in an economic danger zone and worryingly it also shows that we and the Bank of England are continuing to lose the war to bring down or dominate enemy number one – inflation. Inflation is an elusive, wily and powerful foe especially when it builds up momentum, as it is now. There is a strong argument for a 50-basis point hike at tomorrow’s Bank of England's meeting. The Bank needs to take the initiative quickly. The risk for further policy failure is real and the stakes are getting increasingly high.”
 
Jonathan Moyes, head of investment research, Wealth Club
"The inflation data will make for grim reading for anyone looking to remortgage later this year. Inflation just will not be bowled out. Of most concern is the rise in core CPI and services CPI, suggesting that higher food and energy prices are filtering into other areas of the economy and becoming embedded. This is a real headache for the Bank of England, there is a sense that the economy is increasingly fragile, financial conditions are tightening, and yet inflation continues to defy expectations. This could put a 0.50 per cent interest rate rise on the table (vs the 0.25 per cent expected). Too much tightening however, and the bank risks damage to the economy.”

Giles Coghlan, chief market analyst, consulting for HYCM 
"Currently, core inflation reads as one of the worst in the G20 – and at 7.1 per cent year-on-year, further interest rate hikes from the Bank of England are inevitable. While the BoE is unlikely to affirm this picture, interest rate markets project five more 25 bps hikes still to come from the BoE, making for a terminal rate of 5.75 per cent. A 25 bps rate hike is widely anticipated by the markets this Thursday, and the GBP [sterling] is likely to see `a buy the rumour, sell the fact' response. In fact, Seasonax shows that over the last 10 years, when the Bank of England has hiked interest rates, the GBP/USD [dollar] pair has fallen over 80 per cent of the time with an average fall of 1.01 per cent. The Bank of England now has to face the real risk of stagflation to the UK economy and today’s higher-than-forecast inflation print should prove negative to the GBP in the near term."