Why UK inflation at 3% could be bad news for UK stocks

Andrew Cummings
February 14, 2018

Last week's inflation report caught markets on the hop a little with its unexpectedly hawkish message about the prospect for interest rates, in the months ahead. It hit a four-year high of 2.902 percent on Monday.

The CPI data "didn't necessarily disappoint for those believing in a real strong return of inflation story", said Craig Bishop, vice president of USA fixed income at RBC Wealth Management.

The US snapback looks set to spill over into this morning's European open and while further gains are a welcome development, they remain small potatoes in the context of recent losses, to paraphrase out of context, recent comments by William Dudley of the New York Fed.

While ONS reported signs of weaker price rises for fuel and food in January, those were offset by a shallower fall in leisure costs.

The yield on 10-year Treasuries rose to 2.86 percent, while USA stock futures fell, as the figures renewed investor concerns that the Federal Reserve will raise interest rates at a faster pace than anticipated.

The yields on the benchmark USA 10-year Treasury bonds rose to 2.8730 percent after falling to 2.8222 percent earlier.

ONS senior statistician James Tucker said: 'Headline inflation was unchanged with petrol prices rising by less than this time a year ago.

Sterling rose 0.3 per cent against the dollar to 1.38 U.S. dollars following the news that the rate of Consumer Prices Index inflation held steady at 3.0 per cent in January.

The slightly higher than expected year-on-year increase in prices, driven by a higher cost for recreational activities, is likely to reinforce concerns that the Bank of England and other central banks will respond to inflationary pressures by dialing back on cheap credit.

Headline CPI is predicted to slip back to 2.9% for January, however we could see an upside surprise given that January tends to be a month when travel fares see sizeable increases, rail fares being one such example, while commodity prices are also higher than a year ago.

Investors sold US government bonds Wednesday, sending yields jumping, after closely watched data showed inflation firming more than expected in January.

The Bank of England will be hoping that United Kingdom wages show the sort of resilience shown by U.S. wages at the most recent USA employment report.

A Reuters poll on Wednesday showed most economists expect the BoE to raise rates by a quarter of a percentage point to 0.75 percent in May, and financial markets see a roughly 50 percent chance of a further rise before the end of 2018.

EURUSD - now squeezing back up towards the 1.2330 level, but while below here the risk remains for a move back towards the 1.2160 area. We need an urgent change of direction. But two months remain.

The key level to watch is 3% on the 10-year government bond, as that is a key area that could create added pressure on stocks, adds Ripley. My guess is that inflation will continue trending higher, but moderately.

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