UK inflation jumped unexpectedly in February, placing fresh pressure on the Bank of England (BoE) to raise interest rates at its meeting tomorrow.
Data from the Office for National Statistics showed consumer prices index (CPI) rose by 10.4% in the 12 months to February 2023, up from 10.1% in January following two consecutive months of declines.
We look at why inflation is rising, and what it means for you.
Start your trial of MoneyWeek today
Get unparalleled financial insight, analysis and expert opinion you can profit from.
Start your trial
Sign up for MoneyWeek’s free twice-daily newsletter.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
What is driving inflation?
Rising prices at restaurants and hotels were the main drivers of inflation, rising 12.1% year-on-year in February, up from 10.8% in January and the highest rate since 1991. Higher alcohol prices also helped push the headline figure higher.
Latest Videos FromMoneyWeek
More worryingly, food inflation is running at its highest rate in over 45 years. Food prices rose 18.2% in the year to February 2023, up from 16.8% in January, driven largely by vegetables, bread and cereals, and chocolate and confectionery.
The prices of clothing and footwear also jumped 8%. Although it had been expected prices would increase following the January sales, the rebound is the fastest recorded since 2012.
Slowing inflation in the recreation and culture sectors partially offset this growth. Price growth in these sectors slowed from 5% in January to 4.1% in February.
The annual rate of inflation for transport also eased, from 3.4% in January to 3.1% in February.
What does rising inflation mean for interest rates?
The BoE has been hiking rates over the last year to tackle double-digit inflation. The base rate currently sits at 4%, its highest rate since 2008.
The banking turmoil due to the collapse of Silicon Valley Bank and UBS’s takeover of Credit Suisse had led to some predictions the bank would pause hikes to soothe worries about a crisis.
But the latest inflation figures are likely to be a bigger influence on its decision.
“It had been touch and go about whether the Bank of England will raise rates but now with consumer price inflation rising to 10.4% on the month, it looks increasingly likely a hike will be voted through tomorrow,” says Susannah Streeter, head of money and markets at Hargreaves Lansdown.
“Although the banking turmoil will be front of mind, this latest snapshot and ongoing worries about a tight labour market are likely to tip the balance in favour of a rate hike.”
Indeed, it would seem the BoE has “little choice but to keep ratcheting up rates”, says Rob Morgan, chief investment analyst at Charles Stanley.
“Were it not for this hot inflation reading, the next interest rate decision… would have been finely balanced,” adds Stanley. “The extra uncertainty caused by concerns over the health of some banks on both sides of the Atlantic, and the tighter conditions this implies, gives reason to pause. Now the likelihood is that rates will move up further, albeit at the slower pace of 0.25%.”
What next for inflation?
Last week, the Office for Budget Responsibility forecast inflation would fall to 2.9% by the end of the year, but the latest surprise jump shows we still have a long way to go,
“With wage growth easing in January and energy bills saved from a 20% hike in April thanks to Jeremy Hunt’s extension to the Energy Price Guarantee, the road ahead appears brighter,” says Alice Haine, personal finance analyst at investment platform Bestinvest.
But the latest rise in inflation coupled with the banking sector’s turmoil “is raising a fresh set of challenges for the Bank of England, which must now decide whether to push ahead with a widely expected 25 basis point rate hike or put their monetary tightening plans on pause until the banking turbulence passes,” continues Haine.
“If the decision is to pause, this could mean inflation stays high for longer as workers benefit from end-of-tax-year pay rises and, for the lucky ones, bonuses too.”
We could see the rate of inflation fall In the short term. “Inflation should resume its downward trajectory in March, when the strong base effect from the comparison to March 2022 – when Russia’s invasion of Ukraine sent fuel prices skyrocketing – is expected to lower the headline rate,” says Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales.
But even though “Britons are cutting back at the margins, the core factors fuelling inflation are sticky because they form part of essential expenditure for many,” says Myron Jobson, Senior Personal Finance Analyst at interactive investor. “Britons are still spending which is not allowing the economy to cool and is keeping inflation elevated.”
What does rising inflation mean for you?
Everyone’s inflation number will vary, but a rise in the headline figure places fresh pressure on households already struggling with rising bills, higher mortgage costs, falling real wages and April’s tax hikes.
“Higher inflation will pose a fresh challenge for mortgages and the wider property market, as it dents purchasing power - something lenders carefully consider when evaluating a borrower’s suitability for a mortgage,” says Haine.
“Add in significantly higher interest rates than a year ago – and the potential of further rate increases to come – and first-time buyers and those looking to remortgage will find they can afford less house for their money.”
If the BoE hikes rates tomorrow, mortgage rates are likely to remain around their current 5% average.
While savers have benefited from rising rates as banks pass these on to their customers, “inflation needs to dip significantly before savers really start to gain in real terms”, says Haine.
“Moving money languishing in an account with an ultra-low interest rate to one offering better returns now would be a wise move as savings could actually generate a positive return in the months ahead if inflation really does ease rapidly as hoped,” adds Haine.
High inflation also makes it more difficult to save for the long term. “Against this backdrop, people need iron will and discipline to take positive steps with their pension, like increasing contributions,” says Becky O’Connor, director of public affairs at PensionBee.
“Not only is it harder to find the spare cash to make contributions, it also makes it harder to generate a ‘real’ return above inflation, so your money still has purchasing power when you need it later on.”
But pension saving does come with tax relief, so those who can afford to top up their pension could find this a good way to shield their income from the taxman.
