UK inflation is up, but there’s still no sign of second-round effects
The desk interprets the recent commentary on UK inflation as indicative of a temporary environment, given the lack of second-round effects despite rising energy prices. Per the full note from ING, inflation is expected to reach 4% this winter, yet these pressures have not translated broadly into other sectors. This observation provides a solid grounding for the potential Bank of England rate hikes slated for November and February, with the expectation that cuts may follow by the end of 2027 if inflation dynamics remain subdued.
What the desk is arguing
The desk contends that the current inflation environment in the UK poses minimal risk of significant second-round effects, supporting the view that the Bank of England's rate trajectory may be more cautious than aggressive. Per the full note from ING, food inflation has notably remained low, with a month-on-month decline in prices, which contradicts typical inflationary responses to energy price spikes.
Additionally, the commentary highlights that the 'energy intensive' inflation gauge, which covers various high-energy-use sectors, has not shown significant upward movement this year, suggesting that Governor Bailey’s rate hikes may not have the desired impact on curbing inflation. With headline inflation at 3.5% in September aligning with ING's projections, the risk of inflation spiraling out of control appears limited.
As the commentary suggests, absent a broader spillover from energy costs into the inflation basket, the Fed may have room for a more measured approach in their interest rate policy moving forward.
Where it sits in our coverage
Our consensus target for GBP/USD sits at 1.075, within a range of 1.04 to 1.12. Specific Dec-26 targets from notable firms include: - jpmorgan: 1.10 - bofa: 1.04
This desk's view is in alignment with jpmorgan, which holds a relatively higher target, though it diverges from bofa, which appears more cautious in its assessment of inflation's impact on currency strength. Our position sits at the upper bound of the agreed range, suggesting a bullish outlook relative to some competitors.
How other firms see it
Market sentiment is somewhat mixed. Firms like jpmorgan and others appear aligned with our optimistic perspective on the stability of inflation, while bofa offers a more bearish stance, anticipating potential downward revisions should inflation data surprise to the south.
Traders may want to monitor how the GBP/USD pair reacts to news surrounding BoE monetary policy decisions. Equally, the USD/JPY trajectory will be significant as shifts in Fed policy are conveyed in global currency markets.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01UK inflation expected to hit 4% this winter
- 02No signs of second-round inflation effects observed
- 03Food prices showing unexpected declines
- 04Potential rate hikes by BoE could shift market dynamics
Market implications
Traders should keep an eye on the GBP/USD as it aligns with anticipated BoE policy changes, monitoring levels around 1.075. Any surprises in inflation data could alter this outlook significantly, particularly with potential rate hikes ahead.
Risks to this view
A shift in inflation dynamics, especially if second-round effects start to materialize, could invalidate the current thesis. Additionally, a surprising spike in consumer prices in sectors beyond energy could prompt the BoE to enact tighter monetary policies sooner than expected.
Older quick take Quick take Published 07:50 United Kingdom UK inflation is up, but there’s still no sign of second-round effects Inflation is on course to hit 4% this winter. But there's still very little sign that the rise in energy prices is spilling into other parts of the inflation basket. The Bank of England is set to hike rates in November and probably February too.
But assuming second-round effects stay contained, we think officials will return to rate cuts by the end of 2027 Food inflation remains remarkably subdued Seven months on from the start of the Iran War, and there’s still no sign that the UK’s inflation shock is broadening out beyond energy. Second-round effects are so far non-existent. Headline inflation was admittedly a tad above consensus at 3.5% in September, though in line with our forecast.
What’s particularly eye-catching, though, is the month-on-month fall in food prices. This caps a remarkably benign period for food inflation. No doubt it will pick up into the winter, not least given the recent rise in natural gas prices.
But all the models tell us we should be seeing some effect of the energy shock in food – and so far we aren’t. Partly as a result, our calculation of ‘energy intensive’ inflation has actually fallen this year and shows little-to-no sign of picking up. This remains the case even after stripping out last year's increases in water bills and car taxes, which would otherwise distort the picture.
This gauge tracks inflation categories that are classed as having either ‘very high’ or ‘high’ energy intensity by the Office for National Statistics – and range from food to cafés. 'Energy intensive' inflation hasn't picked up this year Source: Macrobond, ING "> Source: Macrobond, ING Services inflation also looks fairly well-behaved. The jump in the headline services CPI to 3.7% (from 3.4%) was exaggerated by airfares, which are notoriously volatile. Remove these jumpy categories, as well as those that are indexed, and the Bank of England’s preferred measure of ‘core services’ inflation is still relatively contained – albeit up slightly over the past few months.
This echoes the calm picture of private-sector wage growth, which sits at 3.4% after accounting for compositional effects. For the Bank of England, this poses a dilemma. While economic growth has been more resilient than feared, and the jobs market is stabilising, there’s very little evidence so far that the energy shock is spilling into other parts of the inflation basket.
Nor is there much evidence that it will do so over the next few months. 'Core services' inflation has nudged slightly higher Source: Macrobond, ING "> Source: Macrobond, ING So when the Bank likely hikes rates in early November, it will be entirely for risk management reasons. The truth is it’s still early days and officials will want another few months of data before concluding that the storm has passed. In the meantime, headline inflation is likely to briefly peak at 4% this winter – something officials have historically argued tends to raise the risks of second-round effects.
We’re less convinced. We expect hikes in both November and February, but by the spring, we think the Bank will be more confident in calling the ‘all clear’ on second-round effects. If we’re right, then we think the Bank can start cutting rates again by next November and into 2028.
United Kingdom Inflation Bank of England Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author James Smith Developed Markets Economist, UK Older quick take
Sources & References
How we cover this story