UK inflation rises slower than expected in July to 2.2%

UK inflation increased to 2.2% in July, marking the first rise in inflation this year, but the increase was less than economists had expected.

According to data released by the Office for National Statistics (ONS) on Wednesday, the annual increase in consumer prices was below the 2.4% rise that the Bank of England (BoE) had anticipated and also fell short of the 2.3% prediction from economists polled by Reuters.

Lower-than-expected inflation

The July inflation figure surpasses the BoE’s 2% target and represents the first uptick in inflation this year. This follows a period of stabilization where inflation had eased to 2% in May, remaining steady in June.

The central bank had forecast a rise to 2.4% primarily due to a smaller decline in domestic energy bills. However, the slower growth in hotel costs contributed to the lower-than-expected overall inflation figure.

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.

This, she added, could pave the way for more interest rate cuts later in the year.

Underlying price pressures fall sharply

The ONS data revealed that services inflation, which the BoE closely monitors as a key indicator of domestic price pressures, dropped significantly from 5.7% in June to 5.2% in July, reaching its lowest level since June 2022.

This drop was more substantial than analysts had forecasted, as they expected a decline to 5.5%.

This sharp fall in services inflation has fueled speculation that the BoE may consider further rate cuts. Rob Wood, an economist at Pantheon Macroeconomics, suggested that the decline in services price growth supports the BoE’s view that inflation pressures are gradually easing.

However, he cautioned that some of the decline could be attributed to erratic changes in airfares and hotel prices, making it unlikely that the BoE would cut rates again at its September meeting.

Market reactions and economic outlook

Following the release of the inflation data, the sterling slightly fell against the US dollar, with the pound dropping by 0.1% to $1.284.

Additionally, UK gilts saw a rally, with the yield on the interest rate-sensitive two-year UK gilt dipping by 0.04 percentage points to 3.56%. Investors are now betting on two more BoE interest rate cuts before the end of the year.

In the broader context, the BoE had already cut interest rates by a quarter percentage point to 5% on August 1, marking the first rate cut since the onset of the Covid-19 pandemic.

However, BoE Governor Andrew Bailey warned against reducing interest rates too quickly or by too much, emphasizing the need to ensure inflation remains low.

The ONS data also showed that annual core inflation, which excludes volatile food and energy prices, fell to 3.3% in July from 3.5% in June, its lowest level since September 2021.

Political and economic implications

The slight rise in inflation in July has political implications as well. For the Labour government, the inflation uptick serves as a reminder of the challenges ahead, particularly for Chancellor Rachel Reeves, who is keen to boost economic growth but must contend with a cautious BoE.

Darren Jones, the Chief Secretary to the Treasury, responded to the inflation data by acknowledging the scale of the challenge facing the government.

Meanwhile, Shadow Chancellor Jeremy Hunt criticized the government’s handling of the economy, urging Reeves not to use the data as an excuse to raise taxes.

The inflation trends in the UK are also part of a broader global context. In the Eurozone, inflation rose slightly to 2.6% in July from 2.5% in June.

In contrast, US inflation was expected to remain unchanged at 3% in July, as separate data released later on Wednesday was set to reveal.

Outlook for interest rates

The latest inflation figures provide the BoE with some room to maneuver. With underlying price pressures appearing to ease, the central bank may consider further rate cuts as the year progresses.

However, the BoE will need to carefully balance its actions to avoid undermining the progress made in controlling inflation.