To The Moon

Driven by surging gasoline and diesel prices, the UK inflation rate unexpectedly climbed to its highest level in 11 months, putting the Bank of England on track to deliver its first rate hike in more than three years.

Data released Wednesday by the Office for National Statistics showed that the Consumer Prices Index (CPI) rose 3.5% year-on-year in September, above the 3.1% recorded in August and market expectations of 3.4%. Core CPI rose 2.8% year-on-year, exceeding both August's 2.6% and the expected 2.7%. In addition, services inflation, a gauge of domestic price pressures in the UK, rose to 3.7%.

The ONS said motor fuel costs pushed inflation higher 鈥?diesel prices hit a record high at the end of September after oil prices climbed above $100 a barrel. Ordinary UK households also face further financial strain, with the price cap that determines household energy bills set to rise in October.

The Bank of England announced last month that it would keep its benchmark rate unchanged at 3.75%. Six rate-setters, including Governor Andrew Bailey, supported holding rates steady, while Catherine Mann, Megan Greene and Huw Pill voted for a 25 basis point increase.

Although Bailey said there is not yet clear evidence of significant second-round inflation effects, he warned that avoiding a rate hike is becoming increasingly difficult as the energy shock and the Middle East conflict persist.

Alongside last month's rate decision, the Bank of England also warned that it may need to raise rates if the Middle East conflict intensifies inflation pressures. The central bank currently expects inflation to reach twice its 2% target early next year and has raised its third-quarter GDP growth forecast to 0.4%.

Against the backdrop of renewed energy price increases and resilient economic growth, the market widely expects the Bank of England to raise rates at its next policy meeting on November 5, which would be its first hike since 2023. Meanwhile, investors currently expect the central bank to raise rates three more times over the next 12 months.

In addition to support from economic data, hawkish signals from Bank of England officials recently have also boosted market expectations for a rate hike. Earlier this month, Catherine Mann said the UK labor market is "static" rather than loose, while warning that inflation pressures are becoming entrenched.

Mann is one of the most hawkish officials on the Bank of England's Monetary Policy Committee and has long argued that rate hikes are needed to prevent the energy shock from spreading into the broader economy. She is also concerned that upcoming wage negotiations will aggravate inflation already driven higher by rising fuel and energy costs.

Another hawkish official, Megan Greene, said last week that the UK economy is growing faster than expected and the job market remains resilient, which is enough to show that the Bank of England's efforts to contain inflation are still insufficient. She said again recently that the current decline in UK wage inflation appears to have stalled above a level consistent with the 2% CPI target, and said bluntly that "the risk of second-round effects is greater than we thought."

The latest data showed that the number of paid employees in the UK unexpectedly increased by 13,000 in September, in sharp contrast with market expectations of an 8,000 decline, marking the largest monthly increase since August 2025. The August figure was also revised up significantly, from an initial reported decline of 26,000 to an increase of 1,000.

In the three months through August, the unemployment rate unexpectedly fell to 4.7%, the lowest level since July 2025; the September unemployment rate held at 4.4%. The ONS noted that although total pay including bonuses has fallen to its lowest level in nearly six years, regular wage growth remains relatively stable 鈥?a finding that echoes Greene's view on wage stickiness.

Investec analyst Ellie Henderson noted that the Bank of England had previously believed labor market loosening would help reduce the risk of second-round effects from the energy shock, but the latest data showing improved employment conditions "may make policymakers uneasy."

Bank of England Chief Economist Huw Pill also warned that upcoming wage agreements pose a threat. He said that in a supply-constrained economy, economic activity and the labor market are showing resilience.

However, in the view of Bank of England Deputy Governor Sarah Breeden, UK companies are seeking to absorb the energy shock themselves and cut costs rather than pass on higher prices to consumers. That stance suggests she is cautious about the need for a rate hike. But she also stressed that whether the impact of the energy shock has been weakened or merely delayed remains an open question.