(Bloomberg) -- UK inflation increased less than economists and the Bank of England had expected, prompting traders to bring forward bets on the pace of interest-rate cuts in the coming months.
The Consumer Prices Index rose 2.2% in July, the Office for National Statistics said Wednesday, lower than the 2.3% expected by economists. Services inflation — watched closely by policymakers for signs of persistent domestic price pressures — posted the lowest reading in more than two years.
While it was the first time the headline rate of CPI rate had risen this year, the data represented a “dovish turn” in the overall trend, said Yael Selfin, chief economist at KPMG UK. This “should provide a degree of comfort for MPC members as the bank’s own forecasts earlier this month pointed to a sharper uptick,” she said.
The BOE had forecast a reading of 2.4% in July and an increase to 2.8% later this year, with Governor Andrew Bailey cautioning against reducing borrowing costs “too much or too quickly.” That left traders anticipating no change until November. The BOE cut rates on Aug. 1 for the first time since the pandemic and meets again Sept. 19.
However, the sharp cooling in services inflation left traders more confident cuts will come in November and December. They still see a less than 50% chance of a move next month. The pound fell as much as 0.3% to $1.2820, but is still the best performing Group-of-10 currency this year reflecting bets the BOE will keep rates relatively high.
What Bloomberg Economics Says ...
“The downside surprise in July’s CPI will need to be backed up with another undershoot in the next CPI release for the BOE to consider cutting in September. A move in November looks more likely.”
—Dan Hanson, chief UK economist. Click to read the REACT.
Services inflation cooled to 5.2% from 5.7%, the lowest reading in more than two years and below the 5.6% the BOE was forecasting. Core inflation, excluding food and energy prices, hit its lowest since September 2021.
Britain took longer to rein in inflation than other Group of Seven economies, but the latest readings show it’s in better shape than the euro area and comparable to the US harmonized rate. UK inflation hit the BOE’s 2% target in both May and June.
READ: Britain’s Poor Hit Most by Soaring Cost of Cheapest Groceries
The data “will reassure the Bank of England that the disinflation process is on track and opens the door to more interest rate cuts later this year,” said Ruth Gregory, deputy chief UK economist at Capital Economics.
The increase in the headline rate in July was largely driven by base effects, with energy bills this year falling less than they did a year earlier. The ONS said that prices in restaurants and hotel were the largest drag on the figures, helping to pull down services inflation.
The figures suggested that a temporary “Taylor Swift” effect in boosting hospitality costs unwound after her tour moved on. Hotel and live music prices helped to pull down services inflation after being sources of strength the previous month. Air fares and package holidays also helped to drive down price growth in the UK’s largest sector.
The rate-setters are concerned that stubbornly high services inflation and wage growth will make it more difficult to achieve its aim sustainably. However, the BOE has played down the significance of the recent strength in services prices, blaming volatile components.
“Despite the lower figures, these remain elevated and may lead the Bank of England to exercise some caution with regards to further interest rate cuts,” said Monica George Michail, associate economist at the National Institute of Economic and Social Research.
The inflation figures come midway through a week of top-tier data that threaten to complicate the BOE’s shift toward lower interest rates.
On Tuesday, there were signs of resilience in the labor market with unemployment unexpectedly dropping in the three months to June after a hiring spurt by businesses. However, wage growth and job vacancies eased further.
Tomorrow, gross domestic product data are expected to show that growth continued at a healthy clip in the second quarter, extending a recovery from last year’s recession. The central bank has warned that the strength of the economy adds to the inflation risks.
Pipeline price pressures continued to ease, with producer prices rising a smaller-than-forecast 0.8% from a year earlier. The cost of fuel and raw materials used by manufacturers was up just 0.4%.
--With assistance from Eleanor Thornber.
©2024 Bloomberg L.P.
