Forex
Why is inflation so high in the UK?
British inflation defied forecasts of a fall in May and stayed far above price growth in the United States and elsewhere in Europe, pressuring the Bank of England to keep on raising interest rates despite the growing hit to mortgage-holders.
Britain has struggled more than other countries with the surging cost of food, a shortage of workers to fill jobs and its heavy reliance on natural gas to generate power and domestic heating, all of which adds to inflation pressure.
Below is an explanation of Britain’s high inflation problem.
HOW DOES UK INFLATION COMPARE TO OTHER COUNTRIES?
Britain’s consumer price index rose by 8.7% in annual terms in May, unchanged from April and defying forecasts among analysts polled by Reuters for a slowdown to 8.4%. Although down from 11.1% last October, it left the country with the highest inflation rate among the Group of Seven advanced economies.
By comparison, inflation stood at 4.0% in the United States and 6.3% in Germany.
WHAT ABOUT CORE INFLATION?
Britain’s measure of underlying inflation that excludes volatile items, such as energy and food, took investors by surprise by accelerating for a second month in a row in May, hitting 7.1%, up from 6.8% in April.
Higher core inflation is seen as a sign that price growth is more likely to remain persistently high.
Another gauge of underlying price pressure that is watched closely by the BoE – services price inflation – also rose. Both increases were the strongest in more than 30 years.
WHY IS FOOD INFLATION SO HIGH IN THE UK?
Britain has had western Europe’s highest rate of inflation for food, with prices up more than 18% over the past year, down only slightly from a recent peak of more than 19%, the highest since 1977.
Freak weather has affected crops around the world, pushing up prices for many countries. But Britain is the world’s third largest net importer of food and drink, according to the Food and Agriculture Organization of the United Nations – behind only China and Japan – leaving it particularly exposed.
Industry data published on Tuesday showed British grocery inflation eased slightly for the third month in a row in June.
BoE Governor Andrew Bailey said last month that British food producers may have locked in higher costs than the BoE had anticipated, explaining some of its underestimate of inflation.
ENERGY PRICES
Britain is highly reliant on imported gas to generate electricity, exposing it to the full force of the surge in gas prices last year after Russia’s invasion of Ukraine.
The way Britain regulates energy prices for domestic and business users – it announces changes to maximum tariffs on a quarterly basis – means that international price rises are slower to push up inflation than in many other countries but falls are also slower to feed through into bills for users.
IS BREXIT PART OF THE PROBLEM?
Britain voted in 2016 to exit the European Union and it left the EU’s single market at the start of 2021. Although London and Brussels have an agreement allowing largely tariff-free trade in goods, there are barriers to exports and imports in the form of paperwork which have caused delays and higher costs.
The end of free movement of workers from EU countries has contributed to a shortage of staff faced by many employers that is more acute in Britain than in many other economies and which has pushed up wages and ultimately prices for consumers.
WHAT DO PEOPLE THINK WILL HAPPEN WITH INFLATION?
The British public’s expectations for rising prices have cooled somewhat in recent months, perhaps the only bright spot for the BoE as it monitors the risk of an inflation psychology becoming engrained in consumer behaviour.
But those expectations remain elevated, contributing to wage growth at levels that makes the BoE uncomfortable about future inflation pressures.
WHAT IS THE BANK OF ENGLAND LIKELY TO DO?
Investors and analysts responded immediately to Wednesday’s data by pricing in more interest rate increases than they had previously been expecting.
Rate futures showed investors saw a roughly 40% chance that the BoE will raise rates by half a percentage point to 5.0% on Thursday and a 60% chance of rates reaching 6% by December.
The British pound continued its historical trend of starting the year on a weak note, marking a seventh consecutive year of losses on the first trading day after New Year’s Day.
Deutsche Bank (ETR:) analysts noted that the pound fell over one percent today, contributing to a long-term pattern where sterling has only posted three positive returns on the first trading day of the past twenty years.
The bank’s analysis suggested that the pound’s performance is not isolated, as the Euro against the U.S. dollar () has shown a similar pattern, though slightly less pronounced. The movements in the Cable, the term used for the currency pair, often align with the repricing of relative interest rates at the start of the year.
However, today’s interest rate movements were minimal, despite a downward revision in the UK’s manufacturing PMI and more favorable unemployment claims data from the U.S.
Deutsche Bank attributed the additional underperformance of the pound to a “beta of the technical breaks” from last year, referencing the fall of the Euro to last year’s lows and the decline of the pound to multi-month lows.
The technical analysis suggests that these breaks in key support levels have contributed to the downward pressure on sterling.
Looking ahead, Deutsche Bank found no strong pattern that would indicate whether the initial losses of the pound on the first trading day would reverse or continue in the week following.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.
Investing.com – The US dollar was trading higher on Thursday, the first day of 2025 trading, on hopes that U.S. growth will beat peers, a more hawkish Fed stance and expectations for the incoming Donald Trump administration.
At 12.30 ET (5:30 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.8% higher to 109.170.
Dollar to remain in demand in 2025
The index rose 7% in 2024 as traders drastically cut back Fed rate-cut expectations in the wake of the projections of the policymakers after the December policy-setting meeting.
The US central bank projected just two 25 bp rate cuts in 2025 at its last policy meeting of the year, a sharp reduction from the four cuts it had indicated in September.
In fact, markets are currently only pricing in 42 bps of cuts from the US central bank in 2025, with the return of Donald Trump to the White House adding a degree of uncertainty given his policies of looser regulation, tax cuts, tariff hikes and tighter immigration are seen as both pro-growth and inflationary.
Focus turns to the release later in the session of weekly numbers as well as the December number, for clues towards the strength of the US economy.
In Europe, traded 0.9% lower to 1.0258, following the more than 6% drop in 2024.
Data released earlier Thursday showed that manufacturing activity in the eurozone declining at a faster rate at the end of the year, offering scant signals of an imminent recovery.
HCOB’s final , compiled by S&P Global, dipped to 45.1 in December, with the downturn broad-based as the bloc’s three largest economies – Germany, France and Italy – were stuck in an industrial recession.
Traders expected more interest rate cuts from the European Central Bank in 2025, with markets pricing in 113 basis points of easing, much more than the Federal Reserve.
This divergence in Fed & ECB policy “will push the euro to parity vs the dollar in the course of 2025,” said analysts at ABN Amro, in a note.
traded 1.2% lower to 1.2366, adding to the fall of 1.7% last year, but was nevertheless the best-performing G10 currency versus the dollar.
UK rose in December, according to mortgage lender Nationwide, jumping by 0.7% in monthly terms during December, following a 1.2% increase in November.
The resilience of the UK housing market has surprised many given indications of weakening activity across the wider economy, with prices ending the year 4.7% higher than their level of December 2023, up from 3.7% in November – the highest annual growth rate since late 2022.
The held interest rates unchanged last month after consumer prices rose above target, and this central bank is likely to remain more cautious than its eurozone counterpart in 2025.
Slowing Chinese manufacturing growth
In Asia, rose 0.6% to 7.3435, climbing to its highest level in over a year after data showed that the country’s manufacturing sector grew less than expected in December.
The reading came just days after government PMI data also showed weaker-than-expected growth in the manufacturing sector.
The prints ramped up concerns over a slowing economic recovery in China, with recent stimulus measures having provided only limited support.
traded 0.35% higher to 157.79, amid a mostly dovish outlook for 2025 from the Bank of Japan.
Investing.com– Most Asian currencies moved in a flat-to-low range on Friday, pressured by strength in the dollar as traders positioned for a slower pace of interest rate cuts by the Federal Reserve in 2025.
Regional trading volumes remained slim on account of the new year holidays, with Japanese markets remaining closed until next week.
The Chinese yuan was among the worst performers in Asia, hitting its weakest level in nearly 16 months as a Financial Times report said the People’s Bank of China will cut interest rates further in 2025.
The yuan, along with its regional peers, was also nursing steep losses in 2024, as the dollar benefited from a hawkish Fed and the prospect of protectionist policies under incoming President Donald Trump.
Dollar at 2-yr high as rate cut bets ease
The and fell 0.1% in Asian trade after racing to a fresh two-year high on Thursday.
The greenback’s latest round of gains came after weekly data read stronger than expected, indicating that the labor market remained strong. A strong labor market gives the Fed more headroom in considering future monetary easing.
The central bank signaled during its December meeting that it will cut interest rates at a substantially slower pace in 2025, citing concerns over sticky inflation.
Resilience in the U.S. economy also gives the Fed less impetus to cut rates, although the Atlanta Fed’s was revised lower for the fourth quarter on Thursday.
Chinese yuan weakens as PBOC flags more rate cuts
The Chinese yuan was among the worst performers in Asia, with the pair rising nearly 0.4% to 7.3275 yuan- its highest level since September 2023.
The FT reported that the PBOC will cut interest rates further in 2025, as the central bank pivots to a more conventional monetary policy structure under a singular benchmark interest rate.
The monetary policy reform comes as a slew of liquidity measures largely failed to stimulate China’s economy over the past two years. This is expected to elicit more monetary easing by the PBOC, which bodes poorly for the yuan.
The yuan was already nursing losses for the week, as purchasing managers index data released earlier showed slowing growth in China’s manufacturing sector.
Broader Asian currencies moved in a tight range, but were nursing steep losses in recent months as traders positioned for a slower pace of U.S. rate cuts in 2025.
The Japanese yen’s pair fell 0.1% after hitting an over five-month high in late-December.
The Australian dollar’s pair rose 0.2%, while the South Korean won’s pair fell 0.2% amid repeated assurances of financial stability from the government.
The Indian rupee’s pair steadied at 85.8 rupees after hitting a record high above 86 rupees earlier this week.
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