UK inflation figures further reduce the prospects of an August interest rate cut

June inflation numbers warmer than expected

Today’s UK inflation numbers for June came in slightly warmer than expected, the annual headline, core and core services rates all remaining unchanged at 2.0%, 3.5% and 5.7%, respectively. Expectations were for all three measures to show a modest decline of 0.1%. The better news was the fall in the headline monthly rate, which rose by just 0.1%, down from 0.3% in May. However, it is the core services number that will be of concern to the Bank of England (BoE), given the importance of this sector to the UK economy, with the unchanged rate suggesting a degree of resilience and pushback against the monetary tightening delivered to date. On its own, this is probably enough to persuade the BoE to delay any intention of cutting interest rates in August, to September.

Services inflation still running too strong

Services inflation is now running over 0.5% stronger than the Monetary Policy Committee (MPC) expected at its last meeting in June. Given the numerous comments various MPC members have made about the need to ensure pockets of stubborn inflation are overcome before monetary policy can be eased, it points to today’s report being sufficient to ensure that rates are kept on hold again at its August meeting. Indeed, BoE Chief Economist Huw Pill warned only this week about the dangers of stubborn pricing pressures continuing to be seen in the services sector - as well as in the labour market - and today’s numbers very much add credence to these concerns. With a still relatively tight labour market allowing wages to grow in real terms, firms are proving able to pass these higher costs onto customers directly through higher prices, a chain of events that has been made easier by the large increases made to the National Living Wage and social security benefits in April, the effects of which appear to be still feeding through into the economy.

A decision to delay a first cut to September remains a close call

However, delaying an August cut remains a close call. Much of the upside surprise in June is attributable to domestic hotel and live music event prices, a temporary phenomenon that will likely unwind going forward; without the impact of these cost pressures, both headline and services inflation would have shown decreases. However, beyond this, there are concerning signs of more deeply embedded pricing pressures. Rents rose by 7.2% y/y, up from 7.0% in May, while the MPC’s own measure of services inflation (services less airfares, package holidays, rents and education) rose by 7.5% on a seasonally adjusted 3-mth-on-3mth basis, up from 6.7% in May, and the strongest print since July last year. Some of this increase is attributable to the indexing adjustments made in April, boosting some CPI components. But the underlying picture is still one of ongoing strength. And it is the size of the CPI services overshoot compared to the MPC’s own forecast that will be most worrying to the MPC and likely to stay its hand from cutting rates next month. While presentationally, any decision to loosen monetary policy becomes that much harder to justify when pricing pressures in the largest sector of your economy are growing at nearly three times above target.

Pricing pressures look set to increase going forward

Going forward, the inflation picture is also looking less benign. The large fall in utility prices seen last July will act to exert upwards pressure on the equivalent figures when they are published next month, while further ahead, the expected hiking of energy prices by around 12% in October by Ofgem, combined with the fact that food and non-energy goods prices have now converged with producer price inflation and therefore have no further to fall, look set to ensure CPI is going to start rising again over H2. Indeed, these components alone have been almost entirely responsible for the falls seen in CPI since its peak in 2022. Accordingly, ensuring CPI remains at its 2% target is going to be challenging for the BoE, and will very much depend on the ability of the MPC in bringing down services inflation.

First interest rate cut expected in September

But the big picture is that inflation is much lower than it was, and even an increase in the headline rate to around 3% by end-year is still significantly lower than the 11.1% peak experienced in October 2022. As such, the BoE will have room to cut interest rates this year. But the pace of this easing looks set to be slow and gradual, and we maintain our forecast of this process starting in September.