The UK’s year-over-year CPI for the month of April has reached 3.7%, which is above the market’s forecast of 3.5%, from 3.4%. The consumer price index or the CPI measures the change in the price of a basket of goods and services in an economy during a period. An increase in this account usually indicates a rising demand in consumption which is of course positive for the economy and the Sterling Pound. You see, a rise in prices general prompts the central bank, in this case – the Bank of England (BOE), to tighten their monetary policies. By removing excess liquidity and lessening the supply of GBP in the financial market, the demand for it increases, making its valuation relatively higher.
Bank of England governor Mervin King, however, belittled the risk of inflation after the UK’s CPI soared to its highest level in two years. He reasoned that this surged in prices is all but temporary and will soon cool off given the excess capacity in the UK’s economy. Despite overshooting the BOE’s inflation target band of 3.0%, he still ruled out the possibility of additional quantitative easing.
The latest RPI, figure, however suggests that the British economy could be on the rise again. The downside to this one is if the bank overlooks the threat of inflation, the country may be at risk of overheating. April’s retail price index or the RPI also jumped to 5.3% from a year earlier from 4.4%, beating the market’s 4.8% consensus. The RPI, unlike the CPI, measures the change in the price of goods and services that are directly consumed by consumers. It differs from the latter as it excludes the cost of housing. In any case, if the RPI is already showing that consumption has grown significantly in spite of some spare capacity, the pace of consumption could only accelerate further if the consumers start to spend a little more.
So if the BOE does not keep this in check, they could be racing to hike their rates once the country’s inflation leaps again. While this may cause some volatility in the market, a rate hike should also be bullish for the pound.