After UK inflation rose faster than expected in January, reaching a 10-month high, wealth managers discuss the impact on potential interest rate cuts and asset allocation.

UK annualised inflation came in at 3 per cent in January, up from 2.5 per cent in December, official figures showed yesterday. The rise was caused by higher food and fuel costs and private school fees, according to the latest figures from the Office for National Statistics. Economists had forecast a smaller rise at 2.8 per cent.

It is thought that the higher-than-expected increase will deter the Bank of England (BoE) from cutting rates soon, as it tries to reach its 2 per cent target. The market is currently pricing in two more rate cuts this year for now.

Core inflation, which takes out food and energy prices, came in at 3.7 per cent in the 12 months to January, up from the 3.2 per cent in December and in line with market expectations. Interest rates currently stand at 4.5 per cent after the BoE reduced them recently.

Here are some reactions from wealth managers to the rise.

Nicholas Hyett, investment manager at Wealth Club
"If there was any doubt about what the Bank of England would do at its March interest rate meeting there isn’t now. Headline inflation has jumped significantly, and came in some way ahead of market expectations. Higher prices for motor fuels and airfares have pushed up transport costs, while food and non-alcoholic drinks saw prices rise 3.3 per cent year-on-year. Both will increase the squeeze on working households, as will the rise in council tax, which has seen owner occupiers' housing costs rocket by 8 per cent in 12 months.

“Making matters worse is the substantial uptick in core inflation – which strips out food and energy prices and is considered a better measure of domestically-generated inflation. With core inflation nearly twice the Bank of England’s target we see little chance of the bank starting to cut rates again any time soon.”

Luke Bartholomew, deputy chief economist at abrdn
“Inflation was always going to jump higher today, but the size of the increase is a bit of disappointment. However, measures of underlying inflation were actually a bit more encouraging, with services inflation coming in slightly weaker than expected. While key Bank of England policymakers recently sounded more concerned about the growth rather than inflation outlook, there is probably not enough in this report to materially move the dial on the near-term outlook for policy. Another rate cut in March looks pretty unlikely, with the Bank continuing with its gradual pace of easing for now. But any speeding up of the pace of rate cuts in the second half of the year will depend on inflation pressures heading back towards 2 per cent.”

“The Bank of England expects it to hit 3.7 per cent in the summer, driven by factors like the price of energy and food, before eventually coming back down to the 2 per cent target. There’s some hope that this spike will be short-lived – and not a drawn-out plateau – but in this very volatile economic landscape nothing is certain,”

Jonny Black, chief commercial and strategy officer at abrdn Adviser, added. â€śFor savers and investors, the message is clear that inflation remains ever present. Cash savings will be particularly vulnerable to being chipped away in real terms, so investing could be key to staying ahead. Financial advisors will continue to play a vital role, helping clients weather these challenges and keep their financial goals on course.” 

Edward Smith, co-CIO at Rathbones Investment Management
“We took the decision last year to strategically shorten the duration of our bond exposure in our multi-asset portfolios, because our modelling suggests it’s one of the simplest but most effective ways to make our portfolios more resilient to interest rate and inflation surprises, which we believe will be more common through the rest of the 2020s. Today’s UK inflation numbers are yet another reason why that seems like a good decision.

“The jump in core inflation back up to 3.7 per cent and a return to 5 per cent services inflation are not good news, especially when one considers that the Bank of England’s decision-maker panel survey indicates that firms expect to raise prices by about 4 per cent over the coming year, and that survey has had a good predictive relationship with core inflation in the past. The upcoming impact of the rise in employers NICs, second round effects from public sector pay rises, and another large hike in the minimum wage all add to the uncertainty.” 

Patrick O'Donnell, senior investment strategist at Omnis Investments
“Headline inflation came in at the highest rate in about 10 months but arguably the labour market report yesterday is more of a problem for the monetary policy committee (MPC) than the inflation data today. Of course, neither helps those looking for a March cut from the BoE. The labour market continues to gradually loosen, although revisions show it is at a slower rate than initially feared. It is also generating very strong wage growth, meaning that it is going to be difficult for the Bank to forecast materially lower inflation over the forecast horizon. The combination means that the gradual and careful rate-cutting strategy from the BoE is going to continue.”

Mike Owens, senior sales trader at Saxo in the UK 
“The Bank of England Governor Andrew Bailey spoke of how the inflation data was not telling us a story about the fundamental state of the economy and initial movements on capital markets are measured. The likelihood of the Bank of England cutting rates at the March policy meeting drops away even further with swap markets are now pricing in a rate cut for May. There is little reaction in GBP with traders seemingly positioned accordingly after days of strong performance, with the pound up 1.6 per cent vs the dollar and 0.9 per cent vs the euro month-to-date.”

Julian Jessop, economics fellow at the free market think tank the Institute of Economic Affairs
"The jump in headline inflation to 3 per cent in January adds to evidence that the UK is heading for stagflation – a nasty combination of stagnating economic activity, rising inflation, and increasing job insecurity. This outbreak could still be mild by past standards, and so best described as 'stagflation-lite'. Three per cent inflation is still tolerably low, and there were some special factors last month including the volatility of air fares and some (hopefully) one-offs, including the extension of VAT to private school fees.

"There is some evidence too that firms are already passing on the increases in labour costs as a result of the Budget. This at least reduces the chances of a further jump in inflation when the national minimum wage and employer’s National Insurance (NI) actually rise in April. Nonetheless, higher inflation will undermine two of the foundations of any recovery in consumer confidence and spending – rising real wages and hopes of further interest rate cuts. The renewed increase in food price inflation will be particularly worrying for households on lower incomes. Moreover, the Bank of England is now more likely to leave rates on hold again until May. In summary, not yet panic stations, but definitely some more bad news."

Paul Noble, CEO of Chetwood Bank
“After today’s result, the hope for inflation coming back under control seems short-lived. For Britons, this is a troubling setback, with households once again facing rising costs just as they were starting to stabilise. With that rate of inflation forecast to rise further before easing, uncertainty remains high.

“While factors driving the uptick – VAT changes and seasonal price shifts – were expected, these offer little comfort as concerns grow over the economy’s fragility. The Bank of England now faces a difficult balancing act. Having recently cut interest rates, policymakers may now be forced to reassess their approach. If inflation remains stubborn, further cuts could be delayed, prolonging financial strain for borrowers and businesses. However, keeping rates higher for too long risks deepening economic stagnation in stark contrast to the stable growth many are seeking. In these uncertain times, inaction is a luxury many cannot afford. There are still competitive deals on the table for those looking to protect their savings, and the most proactive among them at managing their money will reap the benefits. All financial institutions can do at this time is to provide them with clear support and products that will make a difference during tough times.”