Inflation figures released yesterday confirmed that prices in the UK have risen to a new 40-year high. The key CPI reading was higher than expected at 11.1% vs 10.7%. The pound remained relativity quiet following the announcement and closed the day slightly higher against most major currencies.
The Bank of England has been consistently raising interest rates since December last year to try and bring inflation under control. However, bank predictions suggest inflation will peak at 13% before levelling off and eventually falling in 2024.
Interest rates tend to support the value of a currency so one would expect high inflation to strengthen the value of the pound as markets price in future interest rate hikes. However, yesterday’s inflation data presents a real problem for the bank. Spiraling inflation poses a serious risk to economic activity but so does the prospect of interest rates being raised too aggressively.
High interest rates often lead to less investment and a decrease in household disposable income as the cost of borrowing for businesses and mortgage repayments increase.
Later today, Jeremy Hunt will announce the steps the government will take to manage public finances during these difficult times. The now infamous Truss/Kwarteng budget caused a large scale sell-off of the pound with GBPUSD falling to an all-time low. Sterling sellers will be hoping that today’s announcement provides more stability to the markets.
The last budget included tax breaks for the wealthy and an energy support package to help people pay cover bills this winter. This budget is expected to include large scale spending cuts and tax hikes that will bring a new era of austerity. In the short term this could lend support to the value pound. However, in the long term this could prove detrimental for the UK’s economic outlook and the value of the pound. The UK faces a recession, tax hikes could further compound this as disposable income drops leading to less money being spent in the economy.
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