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UK Inflation falls by lower then expected amount


News in today is that UK annual headline CPI inflation for June was 7.9%, down from May’s figure of 8.7%. In monthly terms, CPI was up 0.1% compared to an increase of 0.7% in May. Core inflation (excluding food, energy, alcohol, and tobacco) was 6.9%, which was below May’s figure of 7.1%.


So, what does it mean?

This morning’s inflation report will serve as welcome news to the Bank of England (BoE), reassuring committee members that their fight against inflation is finally starting to yield some results. Falling prices for motor fuel led to the largest downward contribution to the monthly change in the CPI annual rate. While prices for food and non-alcoholic beverages also made a notable contribution to the downward effects, rising by 0.4% in June 2023 less than the 1.2% rise in May.


Even more reassuring is that core inflation – a better gauge of underlying inflation pressures – has come off its recent peak and fallen back below 7%. We continue to expect UK CPI to fall at a faster pace in the second half of 2023. One reason is the effect of lower energy prices will continue to feed through. Moreover, services inflation lags producer services output price inflation, which has been decelerating since the end of last year. Food inflation should also continue to ease.


A key risk to this is wage growth, which continued to increase in May. Whole economy total pay once again accelerated for the 3 months to May to 6.9%. Regular private sector wage growth also increased slightly for the 3 months to May to 7.7%, its highest rate since the series began in 2001 (excluding the post pandemic recovery). At these levels, wage growth remains too high to be consistent with the BoE’s 2% inflation target over the medium term. The risk is that persistent elevated wage growth pushes the UK into a wage-price spiral causing inflation to become entrenched.


As evidenced by the mortgage market, the full effects of previous policy action have yet to be felt by the real economy. Despite the average interest rate on a newly drawn five-year fixed term mortgage increasing to 6.3%, the volume of existing fixed-term mortgages means the average effective mortgage rate for households in the UK has only increased to 2.8%. When these existing fixed-rate mortgages end and households move into new higher rate products the effective mortgage rate will continue to increase. As mortgage payments rise, this will weigh on disposable incomes, which is likely to be a drag on consumption growth.


In conclusion

Today’s reassuring inflation data will be seen as good news to the BoE that their previous rate hikes are finally starting to ease price pressures. Despite this, with inflation still a long way from target and wage growth remaining elevated it is too early for the BoE to celebrate. The bank still has more work to do and will likely increase interest rates further from here.

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