What the UK’s rising inflation means for interest rate cuts
CPI inflation rose to 3.8% in July, up from 3.6% in June. The rise was driven by an increase in service inflation, with the volatile air fares and accommodation services categories collectively adding 0.2 percentage points to inflation.
Meanwhile, an increase in oil prices meant petrol prices rose 1.7% month-on-month between July and June, compared to a 0.9% decline between those months last year
Commenting on the data, Matt Swannell (Chief Economic Advisor to the EY ITEM Club), noted base effects mean CPI inflation is likely to edge up further over the next couple of months and peak in September. Subsequently, inflation should cool gradually, he said.
“The positive contribution from the energy category is expected to fade towards the end of this year and into next. Meanwhile, food price inflation should slowly cool, as the impact of stronger sterling gradually feeds through.
“Though services inflation is likely to remain sticky in the near-term, it will start to soften next year, as pay growth continues to cool and the impact of businesses passing on this year’s increase in employers’ National Insurance Contributions (NICs) fades.”
In the minutes of its August meeting, the MPC sent a clear message that inflation was its priority again.
However, there wasn’t much in today’s release that should add to the committee’s concerns, with headline inflation in line with the Bank of England’s staff projections and its measure of underlying services inflation softening, said Swannell.
“November’s meeting will be a close call, with the hawkish shift at the August meeting leaving much greater uncertainty around the timing of the MPC’s next cut.”
One more cut at most
This was echoed by Adam Deasy (Economist at PwC), who notes that despite recent falls in earnings growth, the Bank of England sees the all-important services inflation figure continuing to rise through the year, and the increase from 4.7% to 5% in July may indicate that it’s right.
This, together with higher-than-expected food inflation through much of 2025, looks poised to push inflation to a peak of 4% later this year, double the Bank’s 2% target, he said.
“Although the path back to target is taking a little longer – and peaking a little higher – than previously expected, as far as the Bank is concerned, we are still on track. The key question is whether the elevated inflation we see on the way embeds itself in expectations and impacts price and wage-setting in the medium-term.
“For now, the combination of faster price rises and resilience in real GDP growth will see Bank sticking to its ‘gradual and careful’ approach, with markets expecting one more cut at most this year.”
