The divergence of UK and US monetary policies looks increasingly odd. Inflation and unit labour cost growth are higher in the UK than the US, while GDP growth and job market conditions are similar – unemployment and underemployment rates in both countries are close to prior-cycle lows. Brexit is negative for UK growth prospects but represents a supply as well as demand shock. Mismanagement of Brexit and a loss of fiscal discipline threaten to exacerbate sterling weakness, entrenching high inflation.

The case for a rise in UK rates is strengthened by today’s news that consumer price inflation rose further to 2.9% in May (2.87% before rounding), significantly above the 2.65% projection for the second quarter in the May Inflation Report. The forecast here remains for inflation to move above 3% during the second half.

The May increase was driven by "core" inflation. The preferred core measure here is the CPI excluding energy, food, alcohol, tobacco and education adjusted for the estimated impact of VAT changes. Core inflation rose to 2.5% (2.53%) in May, the highest since 2012 – see first chart.

Core prices increased at a seasonally adjusted annualised rate of 3.0% in the three months to May from the previous three months – second chart*. If prices were to rise at this rate over the next three months (i.e. June-August), core inflation would increase further to 2.8%, partly reflecting weak core momentum in summer 2016.

Last month's update argued that an acceleration of food prices would contribute to CPI inflation increasing further. Food inflation rose from 1.8% in April to 2.5% in May, with recent large increases in home-produced and imported food material costs suggesting a pick-up to perhaps 5-6% later in 2017 – third chart.

As previously argued, inflation is rising in lagged response to a significant increase in monetary expansion between 2011 and late 2016. The fall in the exchange rate has been part of the “transmission mechanism” from loose money to faster price rises, rather than being a primary driver. The historical evidence is that money growth peaks lead core inflation peaks by between two and three years. Assuming that annual broad money growth peaked in autumn 2016**, this suggests that core inflation will remain under upward pressure through late 2018, at least.

*Seasonally adjusted using X12 procedure.
**Annual growth of non-financial M4 reached 6.8% in September 2016, falling to 5.4% by April 2017.