UK inflation: higher for longer? With last week’s data showing inflation, including services, running hotter than expected, Fund Manager Anthony Rayner, shares in this week’s Perspectives why markets may be pricing in rate cuts, but sticky inflation and rising stagflation risks say otherwise.
Last week saw the release of the latest inflation data in the UK. The three most followed inflation metrics, headline, core (i.e. excluding volatile components food and energy) and services, were all comfortably ahead of consensus expectations. In addition, the chart below shows that these three measures are rising or remain elevated. This flies in the face of the dominant narrative that inflation has been beaten.
Source: Bloomberg Finance L.P - 30.05.2015 – 30.06.2025
Meanwhile, the UK economic growth environment is pretty sluggish. This adds to stagflationary risk and to uncertainty around where UK interest rates are going: should they be cut to buoy growth or increased to ward of inflationary pressures?
Let’s not forget that UK MPC has a two per cent inflation target and will be rightly concerned about the stickiness in services inflation, which is considered a decent gauge of domestic inflationary pressures. Maybe markets are too optimistic about rates being cut? On the other hand, the MPC will also be sensitive to recent labour market weakness.
On top of the uncertainty that higher stagflationary risks cause policy makers, there are also a couple of additional unknowns which haven’t been in the spotlight for quite some time until more recently.
The first is the UK fiscal situation, which is looking increasingly vulnerable, with public sector net debt as a percentage of GDP at almost 100%. The UK government needs a credible strategy to bring down borrowing, as growth is not expected to improve materially. It’s proved very difficult politically to reduce welfare spending, so maybe tax hikes are the next step. The Autumn budget towards the end of October will be insightful here. Economists are already keenly observing the impact on inflation of the April NI hike, specifically whether companies are passing on those costs in higher end prices.
The second unknown is tariffs and, like the UK fiscal situation, this is a topic that has not been a focus for many years. Nevertheless, this can have serious stagflationary consequences. Our global view is that deglobalisation is here to stay, and we also believe higher government spending and increased conflict will remain a feature for some time across economies. Taken together these inform our base case of higher for longer inflation.
The combination of increased concerns around UK debt sustainability and stagflation suggests a limited exposure to UK government bonds. The macro thematic multi asset portfolios barely have any exposure to gilts and where they do, in our Defensive portfolio, duration exposure is limited.
Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
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