Shock inflation figures sent the pound to a year-high against the dollar today as the City bet that the Bank of England could be forced to hike interest rates far sooner than expected.
The Bank’s Consumer Prices Index cost of living benchmark jumped to 2.9% in August, equalling May’s five-year high, just two days before policymakers announce their latest decision, the Office for National Statistics said.
The sharp rise was driven by surging post-Brexit clothing and footwear prices on the High Street as well as rocketing petrol costs.
But the figures sent tremors through currency markets, pushing the pound up almost a cent against the dollar to $1.3270, the highest since September 2016.
Against the euro, sterling also jumped 0.81 cents to €1.1091 after touching eight-year highs earlier this month.
The inflation surprise means Bank of England Governor Mark Carney could have to write to Chancellor Philip Hammond to explain why the cost of living has risen by more than 1% above its official target as soon as next month.
RBC economists predict inflation peaking at 3.1% in October. Today’s rise is also well above the 2.7% increase forecast by the bank last month.
The Bank warned in its August inflation report forecasts that interest rates could rise faster than the City predicts, although until now financial markets have largely ignored the warning and not priced in a first rate rise since 2007 until December next year.
City economists said the latest data, which were seen by the Bank of England’s monetary policy committee last Friday, could prompt swing voters like chief economist Andy Haldane to switch sides and vote for a hike, growing the rate-setting committee’s hawkish contingent.
Scotiabank’s Alan Clarke said he was “mildly nervous that Haldane might dissent”, although most economists expect a 7-2 split in favour of holding steady.
The figures also revealed signs of wider pressure on the cost of living as so-called core inflation, stripping out volatile elements like energy prices and food, rose from 2.4% to 2.7%.
Despite rising inflation, the economy has been stuck in a low-growth rut this year as uncertainty brought about by the Brexit negotiations weigh on businesses and consumers.
Adam Chester, head of economics at Lloyds Bank Commercial Banking, said: “On balance, we think that Brexit uncertainty will continue to trump inflation concerns and rates will remain on hold for now, but the risks are shifting.”
Howard Archer, chief economic adviser to the EY Item Club, said: “We still lean towards the view that the Bank will hold off from raising interest rates until late 2018 but a move before then is starting to look a closer call.
"Our expectation that a hike will be delayed is based on our belief that the economy is likely to remain stuck in low gear.”