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The UK recorded the highest inflation rate for 30 years in March at 7%. But what does high UK inflation have to do with the pound and currency movements?
Why was UK inflation so high in March?
The UK’s annual inflation rate rose to 7% in March, exceeding market expectations of 6.7%. Motor fuels and petrol costs made a large contribution to the high reading, with furniture and household services, gas, electricity and food also rising in price.
There are expectations that inflation could rise even further as the year goes on. The war in Ukraine and elevated energy costs are set to continue, meaning that prices could stay high for some time.
How has high UK inflation impacted the pound?
After this inflation data was released, the pound strengthened slightly against the euro. However, could it have a longer-term impact on sterling?
Inflation is now well above the Bank of England’s target of 2%. There are now rising expectations that the Bank of England will hike interest rates again at its next monetary policy meeting, which could provide support for sterling.
Higher inflation is associated with hiking interest rates, and higher interest rates can attract foreign investment, which is likely to increase demand for the pound.
However, subsequent economic data, which is linked to high inflation, has caused the pound to weaken. UK retail sales fell in March as soaring prices forced consumers to cut back on spending, particularly on food and fuel. Consumer confidence also fell to levels lower than those seen during the 2008 financial crisis.
This caused sterling to fall due to worries about the cost-of-living crisis and UK economy.
How will the Bank of England react?
With inflation so high, many predict that the Bank will continue to raise interest rates. Experts also think that the interest rate will reach 2% within a year.
Bank of England official, Catherine Mann, recently suggested further interest rate hikes are possible and that the UK economy is already seeing signs of ‘stagflation’ – a combination of slow economic growth and high inflation.
The currency markets will now await the Bank of England’s next monetary policy meeting, which is due to take place on May 5. Any comments following this regarding inflation, interest rates and monetary policy could have an impact on the pound.
What does EU and US inflation data look like?
How the pound fares could also depend on other central banks, particularly the Federal Reserve and the European Central Bank. If the Bank of England leads the way with tapering monetary policy and hiking interest rates, taking action ahead of these other banks, this could boost the pound.
European Central Bank officials are still maintaining a cautious approach. However, recent comments from ECB Governing Council member, Martins Kazaks, and Vice President, Luis de Guindos, suggest that an interest rate hike in July is “possible”.
Inflation for the eurozone in March came in slightly lower than expected, at 7.4%. Nonetheless, this was still up from the 5.9% figure in February so supports the rhetoric that the ECB may need to raise interest rates soon.
The dollar has been supported by the Federal Reserve’s stance on interest rates. Federal Reserve officials have suggested that interest rates will continue to be hiked and aggressive action will be taken throughout the year. US inflation is at 8.5%, however, policymakers need to balance tackling this with economic recovery. If interest rates are raised too quickly, this could impact demand and slow economic progress following the pandemic.
How can you protect your business from currency movements?
Although inflation is predicted to rise further this year, it is impossible to predict how the pound will fare in the coming days and weeks. In these uncertain times, it’s wise to protect your business from volatility. Call us now on 020 7898 0500 or email us on [email protected].
