UK inflation falls for second consecutive month

Decreased gas and electricity costs resulted in a significant decline in the main measure of inflation in the UK for July. However, underlying pressures on prices did not decrease as anticipated, which has maintained the pressure on the Bank of England to keep interest rates elevated.

According to data published by the Office for National Statistics on Wednesday, consumer prices were 6.8 percent higher in July compared to the same month a year ago. This decrease from the 7.9 percent increase in the previous month represents the lowest inflation rate since February of the prior year.

This headline figure matched the predictions of economists, offering a bit of relief after unexpectedly strong wage data was released the day before. Nonetheless, a closer look at the details suggests that the UK has not made headway in resolving its inflation challenge.

Discounting food and energy costs, core inflation remained unchanged, with a yearly rise of 6.9 percent in July. Furthermore, the costs of services saw a more rapid increase, adding to the pressure on the Bank of England to maintain a stringent monetary policy in order to restore price stability.

In this month, the Monetary Policy Committee of the central bank increased interest rates by 0.25 percentage points to a 15-year peak of 5.25 percent. Market expectations anticipate a 15th consecutive hike when the committee convenes in September. Forecasts indicate that the Bank of England still has some way to go before effectively curbing inflation, with an additional 0.75 percentage points of rate increases priced in—0.5 percentage points projected for the September meeting—bringing the peak rate to 6 percent. Nonetheless, there is optimism that the Bank of England's cycle of rate hikes will soon come to an end. The committee recently softened its stance, stating in early August that its objective was to maintain elevated rates while minimizing economic harm. However, it reiterated its commitment to keep rates high to ensure that the bank rate remains sufficiently restrictive for an extended period.

A decrease in the quarterly energy price cap contributed to a 15 percent drop in gas and electricity prices in July, leading to an overall 0.4 percent reduction in prices compared to June. Food prices stabilized in July, increasing by just 0.1 percent during the month, consequently bringing the annual rate of food price inflation down from 17.3 percent to 14.9 percent.

Market response to the data was muted, as it closely aligned with predictions. The pound inched higher against the dollar, reaching $1.274, and gilt yields exhibited minimal movement in morning trading. Given the limited changes in the bond markets, the figures are not expected to influence mortgage rates significantly.

However, improvements in energy and food prices were offset by indications that pricing pressures in most other sectors had not moderated. The costs of core goods rose by 0.3 percent over the month, keeping the annual inflation rate steady at 6.9 percent instead of the expected drop to 6.8 percent.

More concerning for the Bank of England was the rise in service prices, which policymakers view as a key gauge of underlying domestic inflation. In July, services prices climbed by 0.8 percent, causing the annual rate of services inflation to increase from 7.2 percent in June to 7.4 percent, marking the highest rate since March 1992. Economists noted that this trend raised concern as it indicated a more deeply entrenched domestic issue of rapid price increases rather than just being a consequence of elevated wholesale energy costs.

Despite the fact that the underlying data demonstrated more pronounced inflationary pressures than hoped for, Chancellor Jeremy Hunt hailed the decrease in the headline figure to 6.8 percent as a step forward in achieving the government's goal of halving the inflation rate within the year. However, he acknowledged that more work was needed, stating, "We're not at the finish line. We must adhere to our plan to halve inflation this year and bring it back to the 2 percent target as soon as possible."

Some economists expressed skepticism about the feasibility of Prime Minister Rishi Sunak's promise, which would necessitate reducing the inflation rate to at least 5.3 percent in the fourth quarter of 2023. The Institute for Fiscal Studies, a think-tank, indicated that there was no certainty that the prime minister would achieve his target, as the bulk of the known improvements in energy and food costs had already occurred, and progress was yet to be seen in mitigating price increases in other areas.