UK inflation jumps to 3.5% — cementing rate hike expectations

U.K. inflation rose by a hotter-than-expected 3.5% in the 12 months to September, driven by the surging cost of motor fuels.

Economists polled by Reuters had been forecasting an annual inflation rate of 3.4%.

September's print marked a continuation of the U.K.'s upward trend for inflation, which came in at 3.1% in August and 2.9% in July. The September reading was the highest annual inflation figure in almost a year.

The U.K.'s Office for National Statistics said on Wednesday that the motor fuel inflation rate had hit its highest level since August 2022, when fuel costs surged in the wake of Russia's full-scale invasion of Ukraine.

Britain is a net energy importer, making it vulnerable to external energy shocks, such as the U.S.-Iran war and the subsequent struggle to move oil through the Strait of Hormuz.

U.K. motor fuel prices surged 29.8% in the year to September, ONS data showed on Wednesday.

The British pound was flat against both the euro and the U.S. dollar following the data release, and yields on U.K. government bonds were also little changed.

Scott Gardner, investment strategist at J.P. Morgan Personal Investing, said in a note Wednesday morning that recent growth in headline inflation had "undone the progress we saw in the spring."

"Bank of England policymakers will be looking beyond the headline figure," he said. "Services inflation, in particular, has accelerated in recent months which will create concern that we are starting to see second round inflationary effects beyond energy prices. While we face a different set of challenges compared to 2021, the prolonged conflict is weighing on the U.K. economy and making the case for a rate hike stronger."

Markets are pricing in a 98% chance that the Bank of England raises its key interest rate by 25 basis points to 4% next month, according to LSEG data, with the majority of traders also pricing in a further hike of the same size at the central bank's final meeting of the year in December.

Wednesday's expected rise in inflation also complicates the fiscal picture for the U.K. government and its finance minister.

Chancellor of the Exchequer John Healey is set to unveil his first fiscal shakeup next week during the U.K.'s hotly anticipated Autumn Budget.