The UK’s inflation rate increased by 2.2% to 2,2% in July. This is the first increase in inflation in this year. However, the rise was lower than expected.
The Office for National Statistics released data on Wednesday that showed the increase in annual consumer prices to be below what the Bank of England had predicted. It also came short of predictions from the Reuters polled economists, who expected a 2.3% rise.
Inflation lower than expected
This is the first increase in inflation since the beginning of the year. The July inflation figure is the first increase in this year. It follows a stabilization period wherein May’s inflation was 2% and remained steady in June.
Central bank forecasted a 2.4% rise, primarily because domestic energy bills had declined less than expected. The slower rate of growth for hotel prices contributed to the overall lower inflation number than expected.
Ruth Gregory, an economist at consultancy Capital Economics, highlighted that the “smaller-than-expected rise” in inflation and the significant drop in services inflation would likely be welcomed by the Bank of England as an indication that labour market conditions are continuing to cool.
She added that this could lead to more rate reductions later in the calendar year.
The price-pressures that underlie the market have fallen sharply
ONS data showed that the BoE’s key indicator for domestic price pressures – services inflation – dropped from 5,7% in June, to just 5.2% in August, its lowest since June 2022.
Analysts had predicted a drop of 5.5%, but this was much more dramatic.
The sharp drop in inflation for services has fuelled speculation about the BoE considering further rate reductions. Rob Wood, an economics at Pantheon Macroeconomics suggested that the BoE’s belief that inflation is gradually decreasing was supported by the fall in service price growth.
He cautioned, however, that some of this decline can be attributed erratic fluctuations in airline and hotel rates, which makes it unlikely the BoE will cut interest rates at its meeting on September.
Economic outlook and market reactions
The pound fell by 0.1% against the US Dollar after the release of inflation data.
The yield of the two-year UK gilt, which is sensitive to interest rates, fell by 0.04 points, or 3.56%. Investors now bet on the BoE cutting interest rates twice more before the year’s end.
The BoE already reduced interest rates on 1 August by a quarter of a percentage point, to 5%. This was the first cut in the rate since the Covid-19 epidemic began.
Andrew Bailey, Governor of the BoE, warned that interest rates should not be reduced too rapidly or too drastically, and stressed how important it is to keep inflation low.
On the other hand, ONS showed that core annual inflation (excluding volatile energy and food prices) fell from 3.5% to 3.3% between June and July, reaching its lowest point since September 2021.
Economic and political implications
A slight increase in inflation for July also has implications on the political scene. The slight rise in inflation for July has political implications as well.
Darren Jones (Chief Secretary of Treasury) acknowledged the magnitude of the challenges facing the government in response to the data on inflation.
In the meantime, Jeremy Hunt, the Shadow Chancellor, criticized the handling of the country’s economy and urged Reeves to not use these data to justify raising taxes.
Inflation trends in the UK also fit into a larger global context. In July, the inflation rate in Eurozone rose to 2,6% from 2,5% in June.
Separate data to be released on Wednesday revealed that US inflation in July was forecast to stay at the same 3% level.
Interest rates outlook
BoE has some flexibility with the latest inflation numbers. The central bank could consider further rate reductions as the year advances.
The BoE must carefully weigh its options to ensure that it does not undermine the gains made by the BoE in controlling inflation.
The post UK inflation rose slower than expected to 2.2% in July may be updated as new information becomes available.
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