In a stunning reversal of conventional economic wisdom, Donald Trump has declared, “I love the inflation,” as US consumer prices surged to their highest in three years. The remark, made during a campaign rally in Ohio, has sent shockwaves through financial markets, with gilt yields spiking and the pound wobbling against the dollar. Meanwhile, pressure mounts on the Bank of England to raise interest rates, as the spillover from across the pond threatens to reignite inflation in Britain.
The Bureau of Labour Statistics reported that the US Consumer Price Index rose 5.4% year-on-year in June, the fastest pace since August 2008. Core inflation, excluding food and energy, also surprised to the upside. Trump, however, seemed unfazed. “We’ve got inflation, and I love it. It means people have money to spend,” he told the crowd, echoing his previous criticisms of the Federal Reserve for being too tight.
The reaction in the City was swift and scornful. A former MPC member described the comments as “economically illiterate, but par for the course.” The yield on the 10-year gilt jumped 12 basis points to 0.87% as traders priced in higher UK rates. The pound fell 0.6% against the dollar to $1.38, reflecting fears of capital flight as US yields become more attractive.
“The market is now expecting the Bank of England to act sooner rather than later,” said Alastair Thorne, Chief Financial Editor. “But the question is whether Threadneedle Street can afford to tighten without choking off recovery. We are caught between the rock of inflation and the hard place of debt-laden public finances.”
UK inflation has already hit 2.1%, above the BoE’s 2% target, and the central bank has signalled it may taper its bond-buying programme. But with the fiscal deficit ballooning to a peacetime record, any rate rise would increase the cost of servicing the national debt, currently at 98% of GDP. The Treasury, already under pressure to extend furlough and business support, faces a tight squeeze.
At a press conference, BoE Governor Andrew Bailey stressed that the rise in prices is “transitory” and due to base effects and supply chain bottlenecks. He said the MPC would not be rushed into tightening prematurely. But some analysts worry that a longer bout of US inflation could force the BoE’s hand, especially if wage demands accelerate.
“If Trump’s fiscal binge keeps the US economy running hot, the Fed will have to hike sooner, and that could provoke a global repricing of risk,” warned Thorne. “The BoE cannot ignore that, but neither can it ignore the fragility of the UK recovery. We are in a policy trap.”
The irony is not lost on Thorne, who recalls the days when inflation was the forgotten enemy. “Now the old foe is back, and it’s wearing a red tie and a smile. The market will have the last laugh, as it always does. Central bankers who pretend inflation is just a passing fancy are at serious risk of losing credibility.”
