MUFG discusses the possibility of a more aggressive monetary policy tightening by the Bank of England (BoE) in response to a concerning inflation print in the UK.
Here are the key takeaways from the text:
High Inflation: The May Consumer Price Index (CPI) in the UK showed an increase of 0.7% month-on-month, which was higher than the expected 0.4%. Consequently, the annual inflation rate remained at 8.7% instead of declining to 8.4% as was anticipated. Additionally, core inflation, which excludes the volatile food and energy prices, accelerated to a cyclical high of 7.1% year-on-year.
BoE's Dilemma: MUFG notes that the BoE faces a dilemma. On one hand, the high inflation print might warrant a more aggressive interest rate hike, possibly 50 basis points (bps), to curb inflation. On the other hand, a sudden and aggressive rate hike could be perceived as the BoE acting in panic and as an admission that it’s losing control over inflation. This might have adverse effects on market confidence.
MUFG's Expectations: Initially, MUFG expected the BoE to hike rates by 25bps but now leans slightly in favor of a 50bps hike given the concerning inflation data. However, they acknowledge that the BoE might still opt for a more cautious 25bps increase and argue that the lag effects of previous tightening will eventually influence inflation.
GBP Reaction: According to MUFG, more aggressive action by the BoE could boost the British Pound (GBP) in the short term. However, the extent of the currency appreciation might be limited as investors start to weigh the potential impact of aggressive tightening on economic growth. They suggest that the GBP/USD might approach the 1.3000 level, but the sentiment could be mixed due to high inflation and perceptions regarding the BoE's policy management.
In summary, MUFG sees the possibility of a more aggressive rate hike by the BoE in response to surging inflation in the UK, but acknowledges that the BoE is in a difficult position. The response of the GBP will be influenced not only by the magnitude of the rate hike but also by perceptions regarding the BoE's handling of the inflation situation.
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