'If inflation expectations become ingrained this could spell trouble'

'If inflation expectations become ingrained this could spell trouble'

The latest inflation hike is regarded by many as a temporary "shock" but trouble could be on the horizon still, said Quilter Cheviot's head of fixed interest research.

Inflation overshot the Bank of England's 2 per cent target for the second month running in June, as it was up 2.5 per cent in a year.

The central bank’s target, which was also overshot in May, was superseded once again by climbing prices in food, clothing and motor fuel, recovering the value they lost in 2020.

On a monthly basis, the Consumer Prices Index (CPI) rose by 0.5 per cent in June 2021, compared to a 0.1 per cent rise in June 2020.

Richard Carter, head of fixed interest research at Quilter Cheviot, said despite breaching the central bank’s target it was still “likely that this bout of inflation won’t be sustained over the long-term”.

Carter said: “The price increases in the UK are being driven by the sectors that struggled since the start of the pandemic.

"Most of these sectors registered negative price growth for many months in 2020 so it’s only natural that prices rise as demand returns.

“The Bank of England will expect this bout of price increases to be transitionary, and one that will likely resolve itself over the next six months as the economy re-opens.”

But he added: “If higher prices seep into the labour market on a sustained basis due to labour shortages, we could see sustained inflationary pressures.

“Likewise, if inflation expectations become ingrained among consumers and producers, this could spell trouble. It is in this situation that the Bank of England will be compelled to act swiftly to remove the inflationary pressures.”

Oliver Blackbourn, a multi-asset portfolio manager at Janus Henderson Investors, agreed that with services prices now running at over 2 per cent, like other goods this could feed through into wages “that could herald more sustained price increases”.

But he also pointed out: “Input and output costs tend to lead inflation figures and showed their first pause in what has been a rapid move higher.

"A further moderation in the coming months would provide further evidence to support the central bank message that, at least for the moment, this phase of higher inflation is transitory.”

Wage data is due out tomorrow. Blackbourn said these are “expected to show further strong gains, despite basic salary rises already being the strongest for over two decades”.

The UK’s target-beating inflation rise reflected that of its stateside neighbour. Yesterday (13 June), the US reported a rise for June which was 0.4 per cent higher than the Federal Reserve’s predictions.

“Following on from yesterday’s consumer inflation surprise in the US, on this side of the pond we have a similar shock,” said Charles Hepworth, a director at GAM Investments.

“[This is] the second month in a row that inflation has been above the critical 2 per cent level since 2019.”