U.K. Inflation Risk Mounts on Record Surge in Factory Costs

U.K. factories saw costs rise at a record pace at the start of 2017, pointing to increasing upward pressure on inflation that could weigh on the economy this year.

A measure of input prices in IHS Markit’s monthly Purchasing Managers Index jumped to the highest since the series began in 1992, it said on Wednesday. The headline activity index for manufacturing was at 55.9, comfortably above the key 50 level that divides expansion from contraction, and a measure of output rose to the highest in almost three years.

The surge in costs reflects the pound’s drop since the Brexit vote and an increase in the price of oil and raw materials such as plastics and steel. As that filters through to other parts of the economy, it could put a squeeze on households and damp consumer spending, one of the main engines of growth in recent years.

Manufacturing lobby group EEF highlighted this risk, saying there’s “mounting evidence” of pricing pressures across industry.

“This does present some risks to the resilience of the U.K. market later this year, in addition to the risks from further sharp swings in exchange rates and a shift in gears in global growth,” said EEF Chief Economist Lee Hopley.

The pound rose for a second day, advancing 0.4 percent to $1.2626 as of 12:56 p.m. London time. Ten-year gilts declined.

The pass-through from the exchange rate is also an issue for the Bank of England, which will publish new forecasts for growth and inflation on Thursday alongside its latest policy decision. While it’s focused on supporting the economy through potential volatility related to the U.K. decision to leave the European Union, its capacity could be constrained by the pickup in prices.

Inflation Outlook

In November, the BOE forecast that inflation will reach 2.7 percent by the end of 2017. Consumers’ one-year expectations rose to 2.6 percent in January from 2.4 percent in December, Citigroup said on Wednesday. Longer-term expectations remained at 3 percent, and Citigroup said the readings probably aren’t high enough to overly concern policy makers.

“With the former below Bank of England forecasts and the latter below the long-run average, the MPC is unlikely to be worried about unanchored expectations,” it said.

Markit also noted that while the weaker pound continues to squeeze manufacturers, the positive exchange-rate impact on exports appears to be “waning.” The report showed growth in new overseas business slowed sharply in January.

Rob Dobson, an economist at Markit, said that companies seem “fairly sanguine,” with a gauge of business confidence at an eight-month high, and said manufacturing could be a “solid” boost growth this quarter.

“It looks as though the sector will continue to make a positive contribution to GDP in the first quarter,” said James Knightley, an economist at ING in London. “However, the consumer sector is showing some cause for concern following the sharp drop in consumer borrowing, weak confidence and the squeeze on spending power.”

— With assistance by Mark Evans, and Harumi Ichikura