Pound Sterling Rallies as Inflation Data Book Another Bank of England Rate Hike

• CPI inflation defies odds for a fall into single digits
• As food and beverages surge in cost
• Investors now see two more BoE rate hikes before peak is reached
• GBP rises across the board 

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The British Pound jumped against the Euro, Dollar and the majority of its peer currencies after a flush of stronger-than-expected UK inflaton figures that seal another interest rate hike at the Bank of England in May.

UK inflation exceeded expectations in all categories: the headline year-on-year increase for March was 10.1% said the ONS, which was down on February's 10.4% but ahead of analyst expectations for 9.8%.

The increase came after a 0.8% month-on-month increase which exceeded estimates for a 0.5% gain.

Core CPI inflation increased 6.2% year-on-year in March, unchanged on February, which was stronger than the 6.0% the market was looking for. The month-on-month change in core stood at 0.9%, which exceeded the estimate for 0.6%.

"This was well above the BoE’s February 2023 Monetary Policy Report projection," says Edoardo Campanella, Economist at UniCredit Bank. "The BoE’s favored measure of domestically-generated inflation, which is core services CPI excluding airfares, package holidays and education, was unchanged at 6.4% year-on-year."

Above: GBP/EUR reaction to the inflation release.

The data will therefore disappoint the Bank of England's Monetary Policy Committee which would have liked to see a sharper slowdown in inflation at this point in the cycle.

Given the strength of inflation, combined with the tight labour market and strong wage increases, another 25 basis point rate hike in May looks likely.

The Pound to Euro exchange rate reacted by spiking to 1.1350 in the half-hour following the release as markets factored in the likelihood of the potential for additional hikes beyond May.

The Pound to Dollar exchange rate rose to 1.2434 as the market expects the UK as a less likely candidate than the U.S. to see its central bank cut interest rates before year-end.

"GBP-USD remains above 1.24, supported by still high UK CPI data for March, with USD dynamics across the board also playing a key role in driving sterling at present," says Roberto Mialich, FX Strategist at UniCredit Bank in Milan.

Markets are now fully priced for a 25bp hike in May, and 60bp in total before a peak is reached, suggesting a further 25bp at some point in the coming months.

"In light of this data, a 25bp rate hike by the Bank of England looks more likely," says Francesco Pesole, FX Strategist at ING Bank. "The lack of evidence of desirable descending paths in inflation and wages will make a hold a harder sell even though we doubt (and we think MPC members do too) that the resilience in inflation will last."

For now, ING says we could see GBP/EUR press again towards the 1.1363 level on BoE hawkish bets.

UK inflation remained above 10% despite a sharp fall in fuel prices as the spike that followed Russia's invasion of Ukraine in 2022 falls out of the data.

But the spike in commodity prices following the invasion has had a lagged impact on other elements of the inflation basket, most notably food, beverages and services.

"The relentless rise in food and non-alcoholic beverages is vicious, soaring to 19.2% in the year to March, up from 18.2% in February. Food prices haven’t risen this quickly over a year since August 1977, when the Queen was celebrating the silver jubilee and a smaller one-pound note was introduced," says Susannah Streeter, head of money and markets, Hargreaves Lansdown.

Above: CPIH, and food and non-alcoholic beverages annual inflation rates, UK, March 2013 to March 2023. "The annual rate for this category in March 2023 is the highest seen for over 45 years" - ONS. Image source: ONS.

The Bank of England has consistently forecast a rapid decline in inflation starting in 2023 that would leave the headline rate at, or below, the 2.0% target by 2024.

Indeed, the February Monetary Policy Report had inflation back at 3.0% in the first quarter of 2024 and 1.0% in the first quarter of 2025.

"These hot data points are a challenge to the Bank of England’s aggressively disinflationary CPI forecasts," says Peter Garnry, a strategist at Saxo Bank.

Frances Haque, Santander UK Chief Economist, says although energy price inflation will reduce CPI in the coming months, this will not affect core inflation, which remains stubbornly high.

"This, coupled with the fact that the latest wage growth data did not fall back much, suggests the MPC still has work to do," says Haque.

Above: CPIH, transport and motor fuels annual inflation rates, UK, March 2013 to March 2023. Image: ONS.

Derek Halpenny, Head of Research for Global Markets EMEA at MUFG says although there is a compelling reason for the Bank of England to now hike by 25bp at the next meeting on 11th May, "the market is fully priced for this now."

As such, "the positive impetus from this data for the pound will likely be contained," says Halpenny.

Next on the economic docket is the release of retail sales figures on Friday at 7AM, followed by PMI data at 09:30.

Any surprises here could offer some near-term volatility ahead of the weekend.