"If inflation becomes unmanageable, the Bank of England may be forced to raise interest rates much sooner than anticipated."
The sharp rise, which breaches the Bank of England's 2% inflation target, has sparked speculation over whether the Bank's MPC will begin to consider a monetary policy adjustment.
On a monthly basis, CPI rose by 0.6% in May 2021, compared with little change in May 2020.
CPIH inflation, which includes owner occupiers’ housing costs, also rose by 2.1% in May, up from 1.6% in April, with monthly growth of 0.5%.
Rising prices for clothing, motor fuel, recreational goods, and meals and drinks consumed out resulted in the largest upward contributions to the change in the CPIH 12-month inflation rate between April and May.
Rachel Winter, Associate Investment Director at Killik & Co, commented: “The jump in UK inflation signals the hustle and bustle of life once more.
“Although the Government now isn’t progressing with the roadmap as previously promised, a clear vision of the country coming out of lockdown has boosted consumer confidence. Inflation has been driven by the rising cost of clothes, fuel and food and drink.
“With the United States exceeding inflation expectations as its consumer price index reached the highest levels since 2008, it will be critical to keep an eye on inflation here. Gradual inflation is beneficial but having too much of a good thing too soon is not. If inflation becomes unmanageable, the Bank of England may be forced to raise interest rates much sooner than anticipated.”
Paul Craig, portfolio manager at Quilter Investors, said: “Inflation is on the up, breaching the Bank of England’s 2% target, yet it remains hesitant to respond by reducing the stimulus it has provided and the quantitative easing that has become so addictive for markets. For now, this is likely the correct decision as we still expect much of the inflation feeding through to be transitory. Wage increases do appear to be coming through, but again this data is so distorted by the furlough scheme that it can’t be seen as a reliable indicator.
“Unfortunately, much of the inflation that is coming through is bad inflation and hitting lower income households in the pocket. How long these price rises continue remains to be seen. Will inflationary pressures be self-defeating or resolved as pent-up demand dissipates or is met with increasing supply. But should it become sustained then it risks making the recovery even more uneven than it already is and thus, it will ultimately fall to government to pull the fiscal levers as it continues in its levelling up agenda.
“The data we are getting continues to be noisy and won’t return to normal for some time. Therefore, don’t be surprised to see things run hot for a period while the BoE assesses the impact. For investors they will need to keep listening closely to the noises coming out of the central banks because as soon as they hint at moving, markets will react quickly. This is why investing in quality businesses is so crucial right now. They are built to withstand multiple market environments and won’t necessarily be phased by spiking inflation and the impacts it could have on central bank decisions.”
Derrick Dunne, CEO of Beaufort Investment, added: “UK inflation continued its ominous climb in May, with the CPI reading surging year-on-year to 2.1%, up from 1.5% in April – beating analyst expectations and, crucially, breaching the Bank of England’s 2% target for the first time since 2018.
“Clearly, an impressive economic recovery is coming. Today’s data once again indicates a promising rise in consumer demand, largely driven by the easing of restrictions and a hearty embrace of the return to hospitality: the strongest upward contributions in May came from transport, clothing, food and recreation.
“But the Bank of England may soon have to take tightening measures. Let’s not forget a few years ago when it started cautiously raising the base rate in the face of a post-Brexit inflation surge.
“That being said, the latest delay to our so-called ‘Freedom Day’ and the impending end of the furlough scheme should temper price rises in the short-term, but the breach of the Bank’s stringent 2% target may already be provoking discussion of a monetary policy adjustment. Investors should still ensure that their plans can withstand both inflationary pressures and a potential rise of the base rate. At this stage, nothing is off the table.”
