The UK’s annual inflation rate fell sharply to 6.8% in July, down from 7.9% in June, as lower energy prices helped to ease the cost of living pressures. However, inflation remains well above the Bank of England’s 2% target and some analysts expect further interest rate hikes to curb the risk of inflation becoming entrenched.
Energy price cap reduces inflation
The main reason behind the drop in inflation was that the big jump in gas and electricity bills in July 2022, when the energy price cap was raised by 9%, was not repeated this year. The cap, which limits how much suppliers can charge customers on standard variable tariffs, was cut by 1% in April 2023 and will stay unchanged until October 2023.
According to the Office for National Statistics (ONS), gas prices fell by 9.3% and electricity prices fell by 8.7% in the year to July, contributing to a 0.6 percentage point reduction in the overall inflation rate. The ONS also said that food price inflation eased to 14.9%, down from 16.3% in June, as prices of milk, bread and cereals fell.
Core inflation and service sector inflation remain high
However, there was less encouraging news for core inflation, which excludes volatile items such as energy, food, alcohol and tobacco. The ONS said this remained unchanged at 6.9% in July, indicating that underlying price pressures have not eased.
Service sector inflation, which reflects the cost of domestic services such as haircuts, restaurant meals and cinema tickets, also rose from 7.2% to 7.4%, suggesting that strong consumer demand and rising wages are pushing up prices.
The ONS deputy director of prices, Matthew Corder, said: “Inflation slowed markedly for the second consecutive month, driven by falls in the price of gas and electricity as the reduction in the energy price cap came into effect. Although remaining high, food price inflation has also eased again, particularly for milk, bread and cereal.”
Bank of England expected to raise interest rates again
The fall in inflation means that for the first time since autumn 2021, prices are increasing less rapidly than wages, which rose by 8.2% year on year in the three months to June. This could boost consumer spending and economic growth, but also add to the pressure on the Bank of England to raise interest rates to prevent inflation from becoming embedded.
The Bank has already increased interest rates 14 times since December 2021, taking them from a record low of 0.1% to 5.25%. The Bank’s governor, Andrew Bailey, has said that these rate rises are “working” and that inflation is expected to peak soon and then fall back towards the target.
However, some analysts and investors are not convinced that inflation will be transitory and expect the Bank to raise interest rates again by another 0.25 percentage point to 5.5% when it meets next month.
Ruth Gregory, a UK analyst at Capital Economics, said: “There will be one more labour market and one more inflation release before the Bank of England’s September policy meeting. But we doubt that they will be weak enough to prevent another rate hike.”