Britain is leaning on higher interest rates as the risk of inflation rises

Britain received another sign on Tuesday that inflation could painfully persist. The country once again braced itself for higher interest rates as bond yields climbed above levels when Liz Truss was prime minister last year.

Data showed that wage growth, a closely watched indicator of how deeply inflation is entrenched in an economy, rose in Britain at the fastest pace in at least two decades.

Regular pay, which excludes bonuses, in February, March and April rose 7.2 percent from a year earlier, Britain’s Office for National Statistics said on Tuesday. That̵[ads1]7;s the most since current registrations began, except during the pandemic, when leave skewed labor market data.

The agency also reported other signs that the labor market was strong, including rising employment, more job seekers and a drop in the unemployment rate. Although these indicators are normally desirable for people’s living standards, they now suggest increasing inflationary pressures.

Traders responded to the data by betting that the Bank of England would raise interest rates even higher.

The labor market data was “almost unequivocally hawkish,” according to economists at HSBC, meaning the numbers favored tighter monetary policy. The HSBC economists said they expected the central bank to raise interest rates by a quarter of a point at its meeting next week, with several policymakers voting for a bigger increase.

For a year and a half, UK interest rates have been pushed higher as the country battles the worst inflation in more than four decades. The Bank of England has raised interest rates to 4.5 percent from near zero by the end of 2021. While inflation peaked late last year in Britain, falling to 8.7 percent in April, it has slowed less than in the United States and in large parts of Europe.

Traders are betting the Federal Reserve could pause rate hikes this week, but the Bank of England may not be able to follow through – despite laying the groundwork for a potential pause months ago – as data continue to point to that inflation is stickier than expected.

Now traders are betting that British policymakers may have to raise interest rates through the summer and keep them high through the fall, reaching 5.7 percent early next year.

Interest rates on British government bonds are higher than when Truss was prime minister in September and October. Her free-market tax-cutting agenda spooked the markets and sent bond yields soaring, sending the mortgage market and pension industry reeling. Yields on two-year bonds, which are heavily influenced by changes in the central bank’s interest rate, rose about 0.2 points to 4.8 percent on Tuesday morning, the highest since 2008.

Under Mrs Truss’s premiership, this high reflected concern about Britain’s fiscal responsibility. Now they point to concerns that inflation will be stubborn and that the central bank will have to raise interest rates and keep them there for longer than previously expected.

Expectations of higher interest rates are again causing turmoil in the mortgage market as some lenders withdraw offers for new mortgage deals.

Jonathan Haskel, a member of the Bank of England’s interest rate-setting committee, wrote in a newspaper column on Monday that “further increases in interest rates cannot be ruled out.”

“As difficult as our current circumstances are, built-in inflation will be worse,” he added.

Late last month, economists at Goldman Sachs said they expected the Bank of England to raise interest rates to 5.25 percent, which would be the highest since February 2008.

Ibrahim Quadri, a Goldman analyst, wrote in a note on Tuesday that he remained concerned that UK wage growth would settle at a level that would be inconsistent with the central bank’s 2 percent inflation target.

While the rapid rise in wages is likely to unsettle central bank policymakers, it will provide limited comfort to many of Britain’s workers as it continues to lag behind inflation. Most are experiencing a real pay cut as the price of food and services rises at the fastest pace in decades.

“Rising prices continue to eat away at people’s paychecks,” Jeremy Hunt, the Chancellor of the Exchequer, said in a statement on Tuesday. “So we must stick to our plan to halve inflation this year to raise living standards.”