UK Inflation Pressures Mount as Borrowing Costs Hit Crisis Levels

The U.K. economy is facing a mounting inflation challenge as borrowing costs surge to the highest levels since last year’s mini-budget crisis, raising the prospect of further interest rate hikes by the Bank of England.

The annual consumer price index dropped from 10.1% in March to 8.7% in April, well above consensus estimates and the Bank’s forecast of 8.4%. However, the figure was still close to a 30-year high and reflected a persistent rise in the cost of food and energy.

The inflation data triggered a sharp sell-off in the bond market, pushing up the yields on U.K. government debt to levels last seen during Liz Truss’ ill-fated premiership. The yield on the two-year gilt climbed to 4.42% and the 10-year yield rose to almost 4.28%, indicating that investors expect more aggressive monetary tightening by the central bank.

The Bank of England raised its base interest rate by a quarter-point to 4.5% earlier this month, the fourth increase since November. However, financial markets are now pricing in another rate hike in June and a further rise to above 5% by the end of the year.

Economists warned that higher borrowing costs would add to the financial pain for millions of households and businesses across Britain, as well as putting pressure on the government’s fiscal plans.

“For anyone with a fixed rate mortgage due to expire in the next few months, this is incredibly unwelcome news, and the longer that higher rates endure, the more people will find themselves facing far higher mortgage rates, and no idea how to cover the cost,” said Sarah Coles, head of personal finance at Hargreaves Lansdown.

British lenders including Nationwide scrambled to raise mortgage rates on Thursday and smaller players temporarily withdrew products, in response to soaring market interest rates.

The government, which has borrowed heavily to support the economy during the pandemic, will also face higher interest payments on its debt. The Office for Budget Responsibility estimated that a one percentage point increase in gilt yields would add £21 billion to debt interest spending by 2025-26.

Rishi Sunak, the chancellor of the exchequer, has pledged to halve inflation by the end of the year, but analysts said this target was looking increasingly unrealistic.

“The broad-based strength in the U.K. inflation print makes a 25 basis point hike to interest rates at the Bank’s June meeting a done deal,” strategists at BNP Paribas said in a note.

The Bank of England has maintained that inflation is largely driven by temporary factors related to the pandemic and Brexit, and that it will subside as supply bottlenecks ease and demand moderates.

However, some economists have argued that inflation is more entrenched and reflects structural changes in the global economy, such as rising wages, higher commodity prices and increased environmental regulation.

“Unless policymakers take action now to tackle some of these drivers of inflation – such as skills shortages and supply chain disruptions – then we could see prices remain elevated for some time,” said Tej Parikh, chief economist at the Institute of Directors.

Reference：

• UK borrowing rates close in on last year’s ‘mini-budget’ crisis levels | CNBC | May,25,2023
• Soaring UK borrowing costs force lenders to hike mortgage rates | Reuters | May,25,2023
• Bank forecast to raise rates above 5% as UK inflation falls by less than expected | The Guardian | May,24,2023