The pound has surged after UK inflation in June hit 1.9%, ahead of investor expectations, handing the Bank of England more ammunition for a rise in interest rates.
The consumer prices index (CPI) grew by 1.9% in the year to June, up from 1.5% in May, according to the Office for National Statistics. Investors had been expecting a more moderate rise to 1.6%.
The figures caused a surge in the pound, which jumped from $1.7078 to $1.7162, back towards the six-year high it reached at the beginning of the month. The FTSE 100, which had been up by more than 0.2%, fell into the red on the news before recovering to trade flat at 6,744 points.
Price rises for clothing, food items and air fares were behind the jump in inflation. 'Clothing prices usually fall between May and June as the summer sales season begins but this year the average price of a number of products have risen,' said the Office for National Statistics.
Food and non-alcoholic drinks also rose, reversing a trend which had seen prices decline in May. Air fares rose as usual between May and June, having fallen in 2013.
James Knightley, economist at ING, said the figures had taken the market by surprise, and pointed towards a rise in interest rates in November.
'With the economy likely growing at 3%+ rates in both 2014 and 2015, jobs being created in significant numbers and company order books looking in their best shape for many years, the amount of spare capacity in the UK economy is being eroded,' he said.
'This should lead to a gradual build-up in domestic inflation pressures and given the Bank of England is targeting inflation in two years' time, not what it is doing right now, we favour a rate hike in November.
'This would also remove political concerns of waiting until next year when election campaigning is in full swing and should keep sterling supported.'
Chris Williamson, chief economist at Markit, agreed November now looked 'the most likely month for the first hike', adding that house price data showing a 10.5% rise compared to a year ago, and a 20.1% jump in London, was an 'additional concern'.
'With inflation almost hitting the Bank of England's 2.0% target, the housing market booming, the economy growing strong with no signs of momentum being lost and unemployment plummeting, the case for higher interest rates is building,' he said.
Housing costs such as mortgage interest payments and council tax are not included in the CPI, although they are factored into the retail prices index (RPI), which also rose from 2.4% in May to 2.6% in June.
But he added that levels of pay, rather than the current rate of inflation, would be the most important factor in determining the timing of a rate rise. Labour market statistics will be released tomorrow, although policymakers have stated their concerns that official data could be understating pay growth.
'Although the official measure of employee earnings remains surprisingly subdued, forward-looking indicators of pay growth are flashing warning lights, suggesting pay pressures are rising, which is in turn perhaps already feeding through to higher inflation.'
House builders, which have enjoyed a strong run off the back of historically low interest rates, were the worst performers on the FTSE 100 following the news. Barratt Developments (BDEV) shed 7.9p, or 2.2%, to trade at 360.3p while Persimmon (PSN) lost 19p, or 1.5%, to trade at £12.30.
Tool hire company Ashtead Group (AHT), which has benefited from the UK's construction boom, dropped 4p, or 0.5%, to 892p. Industrial suppliers Wolseley (WOS) and Travis Perkins (TPK) fell 1.5% and 0.6% to £31.80 and £15.80 respectively.
Impact on savers
Following the rise in CPI, a basic rate taxpayer would now need to find a savings account paying 2.38% per year in order to beat inflation, while a higher rate taxpayer would need one paying 3.17%, according to comparison site Moneyfacts.co.uk.
It said that of 615 non-ISA accounts on the market, 29 offered inflation-beating returns, while 43 of 210 ISAs offered rates that beat inflation.
The best fixed rate ISAs are being offered by Julian Hodge bank and Leeds building society, which pay 2.85% per annum over five years. The highest rate available on a fixed rate bond is available through Vanquis bank, which offers 3.25% per annum over five years.
'Although savings rates are still dire, savers do at least have a few accounts they can choose from that will leave them with some form of return after tax and inflation pressures,' said Sylvia Walcot, editor at Moneyfacts. 'A year ago inflation hit 2.9% and Moneyfacts reported that there was not a single ISA or non-ISA account on the market that paid an interest rate that negated the effects of inflation and, for non-ISAs, the taxman's cut.'