UK inflation stops falling, raising the chances of much higher interest rates

By Olesya Dmitracova, CNN

London (CNN) — UK inflation unexpectedly stayed stuck at 8.7% in May, making it more likely the Bank of England will continue raising interest rates, potentially taking them to a level not seen in more than two decades.

The data released by the Office for National Statistics Wednesday defied forecasts for a slowdown in inflation to 8.4% compared with a year ago. Prices for recreation and cultural activities rose at a faster pace than in April and, although food inflation eased, it remained high, coming in at more than 18%.

“The cost of airfares rose by more than a year ago and is at a higher level than usual for May,” said ONS chief economist Grant Fitzner. “Rising prices for second-hand cars, live music events and computer games also contributed to inflation remaining high.”

Core inflation — which strips out volatile food and energy costs and is a better gauge of the underlying trend in prices — rose last month, hitting a 31-year high of 7.1%.

This marks the United Kingdom out from other advanced economies, including the United States and the 20 countries that use the euro, where core inflation has started to ease, noted Neil Shearing, chief economist at Capital Economics.

“Inflation appears to have infected the labor market and wage-setting to a greater extent in the UK than elsewhere,” he said, adding that Bank of England was now more likely to raise borrowing costs by half a percentage point Thursday, rather than a quarter point as had been expected.

The shock is bad news politically for UK Prime Minister Rishi Sunak, who has promised to halve inflation this year to around 5%, and economically for millions of people across Britain struggling with a cost-of-living crisis and facing soaring mortgage payments, with interest rates on two-year loans now above 6%.

The interest rate on the typical UK mortgage, a two-year fixed-rate loan, has been climbing since the start of May, and further rises are on the cards as banks expect increases in their own cost of borrowing.

‘Mortgage bomb’

Craig Erlam, a senior market analyst at trading platform OANDA, said markets now saw the central bank’s main interest rate reaching 6% early next year. That would be the highest level since early 2000 and, Erlam said, “could be very damaging and increases the risk of the economy buckling under the pressure.”

According to UK Finance, an association of banks and financial service providers, 800,000 fixed-rate mortgages are due to expire in the second half of this year, raising the specter of an unaffordable jump in payments when borrowers refinance.

“People are very concerned with what has been described as the mortgage bomb about to go off,” UK lawmaker Jake Berry said Tuesday in parliament.

Stubbornly high inflation is also pushing up yields on UK debt, making it more expensive for the government to borrow money. Official data also out Wednesday showed that Britain’s public sector debt — at £2.6 trillion ($3.3 trillion) — has surpassed the country’s total annual economic output. The last time the debt-to-GDP ratio was above 100% was in 1961.

Before May, year-on-year inflation had fallen for two consecutive months.

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