UK inflation and CPI have beaten expectations, so why are people worried?

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nflation is up for the UK, but does the saying 'what goes up must come down' always hold true? And what does the news mean for investments and the wider financial sector?

This is a strong reading from UK CPI, +2.1% CPI year on year, and the first time in almost two years that the number has beaten the Bank of England’s 2% target. On its own, the CPU pick-up reflects higher prices as the economy emerges from lockdown, and therefore supports the central bank’s current view that the inflation surge will be temporary.

Separately, input data from the Producer Price Index recorded a +10.7% year-on-year rise in May, showing clear pressure on prices of raw materials, fuel and transport pushing up the cost of goods for producers. This is pretty ominous, and echoes recent comments from Bank of England chief economist Andy Haldane that further high street inflation cannot be far behind.

UK headline inflation CPI reached 2.1% year on year in May, beating economist consensus expectations of 1.8%, and also higher than the 1.5% rate in April. On a month-on-month basis, CPI rose 0.6% (0.3% expected, 0.6% prior). Excluding the volatile food and energy components, core CPI rose 2.0% year on year, against expectations of just 1.5% and April reading of 1.3%. Meanwhile, the Retail Price Index (RPI) came in in line with expectations. The headline read 3.3% year on year, while RPI excluding mortgage payments actually came in lower than expected, at 3.4%. Also in the release, the Producers Price Index rose 4.6% year on year (expected 4.5%, 4.0% prior).

Although inflation came in higher than expected, the details showed price increases to be consistent with reopening of the UK economy post Covid-19. In particular, key drivers of high price increases came from base effects, higher energy prices, as well as jumping restaurant and hotel prices, among others. It remains to be seen if high inflation is transitory or not.

Nevertheless, we would reiterate that inflation risks remain to the upside due to the scale of stimulus and the UK economy reopening. In addition, the Bank of England governor Andrew Bailey has made it clear it will not tolerate consistently above-target inflation of 2%. As a result, our preference is to hold inflation-linked government bonds rather than nominal government bonds in multi-asset portfolios.

The inflation data serves as further evidence that that the UK economy is moving in the right direction at a significant pace. For many early-stage businesses, however, the significant rise in inflation may trigger fears of a subsequent rise in interest rates, directly impacting how much they are able to borrow at a crucial time when many expected the economy to full reopen again.

Therefore, the biggest problem for growing early-stage companies may be access to funding. As we focus on economic recovery, it remains critically important that scale-up businesses – particularly in high-growth sectors such as digital technologies and life sciences – are supported, as they will be at the very heart of economic growth as we create an economy fit for the 21st century.

Government initiatives such as the Enterprise Investment Scheme (EIS) have never been more important for helping entrepreneurs and innovators source the funding they require, while also offering private investors with tax incentives to develop UK-supporting private equity portfolios.

With our EIS funds reaching record levels of funding in 2020-21, it is evident that there is considerable demand from investors and financial advisers alike to invest in early-stage UK companies which we believe will be at the forefront of our economic recovery.