UK inflation drops to 2.6% as BoE rate hike odds fade
A dip in UK inflation to 2.6% buys the Bank of England time to pause rate hikes next week, but resurgent energy prices threaten to reverse the progress and squeeze the new government's fiscal headroom.
UK inflation slowed to 2.6% in the year to June, down from 2.8% in May, offering temporary relief for markets ahead of the Bank of England's policy meeting next week. The Office for National Statistics attributed the decline primarily to a drop in motor fuel prices. "A fall in motor fuel prices, particularly diesel, helped ease inflation in June," said ONS chief economist Grant Fitzner.
Food and clothing prices also retreated. Supermarket competition drove food inflation down 0.2% month-on-month, with notable price drops in chocolate, sugar and beef. However, food inflation often has a supply chain lag of up to 13 months, meaning the full impact of the war in Iran may not yet be visible.
The data effectively rules out a rate increase when the Bank's monetary policy committee convenes next week. "Rate-setters may want to assess the impact of any measures announced by the new Prime Minister before deciding whether to tighten policy again," said Suren Thiru, chief economist at the Institute of Chartered Accountants in England and Wales.
However, economists warn this dip is likely the low point for the year. Yael Selfin, KPMG's chief economist, said the June figure is "likely to be the lowest of the year," pointing to upcoming increases in Ofgem's energy price cap.
Geopolitical risks compound the inflationary outlook. Fuel prices had fallen in June after the US and Iran halted military operations and reopened the Strait of Hormuz. The recent resumption of hostilities and a jump in crude oil prices threaten a near-term inflation spike.
The new government is attempting to insulate the economy from these pressures. Prime Minister Andy Burnham has prioritized the cost of living, with Chancellor John Healey announcing a return of the £2 bus fare cap in January and scrapping VAT on domestic electricity bills from October. "Both these changes are a win-win. They help keep inflation down, while helping people afford the essentials," Healey said.
Yet fiscal space is tightening. Thiru warned that rising inflation will "likely become a more notable economic headache" for the Chancellor, "squeezing his fiscal headroom, raising borrowing costs, and increasing financial market volatility."
Retailers are also feeling the margin pressure from intense price competition. "If retailers are to keep prices affordable for consumers in the long run, the Government needs to take practical steps to lower the everyday cost of doing business," said British Retail Consortium economist Harvir Dhillon.
Selfin cautioned that if elevated energy prices persist, "second-round effects risk feeding through into wages and more broadly across the economy," keeping the Bank of England's 2% target out of reach.
