Prepare for an Inflation Shocker Warns ex-MPC Member Sentance

City economists might be far off the mark with regards to Wednesday's inflation print. Image © Adobe Images

The Bank of England, City economists and 'the market' are far too optimistic in their expectations for a sharp fall in UK inflation to be reported by the ONS on Wednesday.

According to economist Andrew Sentance, a former member of the Bank of England's Monetary Policy Committee, inflation will print at 2.7% year-on-year in April, which is well ahead of the consensus expectation for a fall to 2.1% y/y from 3.1% in March.

"My forecast of 2.7% UK CPI inflation is much higher than Reuters consensus of 2.1% among City economists. They appear to be greatly underestimating the momentum of underlying inflation coming from wage rises and the services sector," says Sentance.

Above: The Bank of England's May forecast update shows it expects inflation to fall to 2.0% in the second quarter.

If Sentance is correct, a sizeable upside surprise awaits, potentially scuttling any hope for an interest rate cut at the Bank of England this summer.

The erasure of bets for a June cut that would follow a significant upside surprise, as well as plummeting odds for an August move, would potentially result in a sharp selloff in UK sovereign bonds.

This would push yields and Pound exchange rates higher.

There appears to be significant uncertainty on the outcome, with one analyst warning the Pound could fall sharply if softer-than-forecast inflation ultimately triggers back-to-back rate cuts.

The sharp drop in inflation that is expected by the Bank of England and City economists relies on April's big drop in household energy bills as the mandated price cap was lowered "around 12%".

In a thread on Twitter, Sentance explains falling energy prices "can only deliver 0.4% of an expected 1.1% fall. And there many other sources of inflation around."

"Markets and the public have been hooked on low inteeeat rates and interest rate cuts for far too long. Time to adjust to the “new normal”. I think if market expectations are in line with the Reuters survey, there will be a big shock on Wednesday," says Sentance.

Expectations for a rate cut in June or August were bolstered Monday by outgoing Bank of England Deputy Governor, Ben Broadbent. He said in a speech, "The MPC will continue to learn from the incoming data and, if things continue to evolve with its forecasts – forecasts that suggest policy will have to become less restrictive at some point – then it’s possible Bank Rate could be cut some time over the summer."

Given the Bank expects inflation to be announced at near 2.0% tomorrow, his assumptions and expectations for an imminent rate cut could be upended.

"Ben Broadbent hints in final BoE speech he favours a cut in interest rates this summer. Broadbent took over from me on MPC 13 years ago, then became Dep Gov. He’s always been pretty dovish and spent 2010s justifying ultra-low interest rates. So no surprises in this last speech," says Sentance.