UK inflation experienced an unexpected uptick to 2.2% in July, primarily driven by a less significant decline in energy prices compared to the previous year.
City analysts had initially anticipated a rise to 2.3%, while the Bank of England had forecasted an increase to 2.4%. However, the actual rise was lower, revealing a variance between projections and reality that has notable implications for economic policy. According to the Office for National Statistics (ONS), service inflation, a crucial indicator for the Bank, fell sharply to 5.2% from 5.7%, significantly below the expected 5.6%. Core inflation saw a marginal decrease, slipping from 3.5% to 3.3%.
In response to the inflation news, the pound depreciated by 0.2% against the dollar, settling at $1.283. This currency movement underscores investor speculation regarding potential interest rate reductions in forthcoming months. The slower decline in energy prices over the past year has been a contributing factor to the elevated headline inflation, exacerbated by the significant hikes in oil, gas, and electricity costs in the aftermath of Russia’s invasion of Ukraine in February 2022.
Grant Fitzner, Chief Economist at the ONS, elaborated, “Inflation ticked up a little in July as although domestic energy costs fell, they fell by less than a year ago. This was partially offset by hotel costs, which fell in July after strong growth in June.” Analysts had speculated that Taylor Swift’s Eras tour might have temporarily inflated accommodation costs in June.
The rise in inflation presents a substantial economic hurdle for Prime Minister Sir Keir Starmer, who has committed to stimulating GDP growth and restoring stability after a period of frequent policy changes under the previous Conservative government. Meanwhile, new estimates from the ONS, expected on Thursday, indicate that the UK economy grew by 0.6% over the past three months, a slight decrease from 0.7% in the first quarter.
Darren Jones, Chief Secretary to the Treasury, acknowledged the impending challenges: “The new government is under no illusion as to the scale of the challenge we have inherited, with many families still struggling with the cost of living. That is why we are taking tough decisions now to fix the foundations of our economy, so we can rebuild Britain and make every part of the country better off.” Chancellor Rachel Reeves is set to announce tax increases in her first budget on 30 October, following a government overspend of £21.9 billion.
The inflation rise comes just two weeks after the Bank of England reduced interest rates by a quarter point to 5%, marking the first reduction since March 2020. Despite ongoing concerns regarding high services inflation and wage growth, which could keep inflation above target, the Bank is expected to continue lowering borrowing costs, with another 50 basis points cut anticipated by the end of 2024.
Recent data has also shown a slight decrease in unemployment, from 4.4% to 4.2%, prompting speculation about the Bank of England’s next move at its upcoming Monetary Policy Committee meeting on 19 September. Wage growth has also moderated to 5.4%, the lowest level in nearly two years. Yael Selfin, Chief Economist at KPMG UK, remarked, “Despite a modest rise, inflation was relatively subdued in July as weaker core and food price inflation largely offset the diminishing impact of earlier falls in energy prices. This should provide a degree of comfort for MPC members, as the Bank’s own forecasts earlier this month pointed to a sharper uptick.”
The unexpected rise in UK inflation to 2.2% in July, driven by a slower decline in energy prices, presents significant challenges for policymakers. Despite this, the Bank of England is likely to proceed with further interest rate cuts to balance economic growth and inflation concerns.
