UK inflation jumps to the highest level in two years – a short-term blip or the start of something bigger?

UK inflation rose to 2.1% in May, the highest level in two years. Saloni Sardana looks at what’s behind the rise.

UK inflation rose to the highest level in two years in May 2021, with CPI inflation hitting 2.1% as Britons took advantage of the easing of Covid restrictions to spend some of their pent up savings. 

May’s Consumer Price Index (CPI) figure was significantly higher than April’s 1.5%, and beat economists’ predictions of a 1.8% rise, says the Office for National Statistics (ONS). 

Core inflation, which excludes volatile items such as food and energy, jumped 2% compared to last year, the highest since August 2018. 

The Bank of England has a CPI target of 2%. 

Why has inflation risen?

Rising prices for transport, clothing, recreation and culture “exerted upward pressure on prices,” between April and May 2021, said the ONS. 

Recreational goods, such as computers, DVDs and music, also saw a surge in prices, but were partially offset by reductions in the price of food and non-alcoholic beverages. 

Some of the fuel-price increase is because, with almost every major economy placed under lockdown in May 2020, energy prices crashed. But the energy sector recovered quicker than expected, driving up prices. 

As for clothing prices, many retailers had slashed prices when lockdowns began to encourage buying online in the early days of the pandemic. But the reopening of the UK’s retail sector in April 2021 has prompted many outlets to increase prices. 

Then there’s the fact that people are buying more clothes to make themselves look pretty as human interaction resumes. “As zoom calls were ditched in favour of face to face meetings there was certainly a good excuse for people to refresh their wardrobes, certainly the bottom half. After months of discounts, retailers had a captivated market and made the most of it - clothing and footwear costs were up 2.3% from the month earlier,” says Danni Hewson, financial analyst at AJ Bell. 

This morning inflation’s numbers will have investors pondering  just “how transitory price rises are in the UK with inflation now above the Bank of England’s target for the first time since July 2019,” says Jeremy Thomson-Cook, chief economist at international business payments firm Equals money. 

Will the Bank of England raise interest rates?

So the big question facing investors is whether the Bank of England will raise interest rates. Higher interest rates make saving more attractive, which can cause an appreciation in the country’s currency. The pound rose around 0.3% against both the euro and the dollar. 

The Bank of England is aligned with both the US Federal Reserve and the European Central Bank in arguing that any inflation will be short-lived as a result of economies reopening. 

Andrew Bailey, governor of the Bank of England, has spent months watering down speculation that higher inflation data may prompt the central bank to raise the UK’s base rate – which currently sits at 0.10%. 

Sarah Coles, personal finance analyst at Hargreaves Lansdown, thinks the BoE will hold off for now: “The Bank of England was always expecting inflation to overshoot its target this spring, but it has taken the position that this is a short term blip caused by rock bottom prices a year earlier, and as soon as they naturally fall out of the figures, inflation will drop away again.

“This is good news for borrowers, but brings yet more misery for savers. It means we can’t expect savings rates to rise across the board any time soon, and we need to track down the best deals on the market today,” she adds. 

But not all market watchers agree. Paul Dales, chief UK economist at consultancy Capital Economics, expects inflation to rise beyond his initial prediction of 2.6% this year following the reopening of the economy. 

So what should investors do now? Do you prepare for inflation or believe that rising prices will be transitory? 

With the UK’s full reopening delayed by a further four weeks, it is hard to see why prices won’t creep even higher. But a lot of that has to do with how the economy fares once the UK withdraws its furlough support on 30 September (until then the government is paying 80% of wages). 

As Andrew Jones, portfolio manager at Janus Henderson points out: “with demand strong, increasing cost pressures in a number of areas and weak base effects, inflation is likely to remain above target for the foreseeable future.”

So, the best thing investors can do is inflation-proof their portfolios, and perhaps that means buying some gold.

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