Could the UK inflation crisis be at a turning point?

The unexpected drop in UK consumer price growth last month has led to cautious predictions that the country’s inflation crisis has reached a turning point.

The news that annual inflation declined to 7.9 per cent in June from 8.7 per cent in May also made the UK look less like an outlier among advanced economies.

“While one swallow doesn’t make a summer, there will be real hopes that this marks a turning point for UK inflation,” said Nicholas Hyett, investment manager, at the investment service company Wealth Club.

The figures came after months of disappointing inflation data and strong wage growth that pushed up interest rate expectations and created turbulence in the mortgage markets.

While the drop was largely driven by motor fuels, which were down by an annual rate of 22.7 per cent, there were broad-based downward pressures among most goods and services.

Core and services inflation, both closely watched measures of underlying and domestic price pressures, also started to ease after hitting a three-decade high in May.

The data also prompted markets to reassess their estimates of how high the Bank of England will need to raise interest rates to stamp down on inflationary pressures and return the headline rate to its 2 per cent target.

Markets are now predicting that the central bank will raise rates from the current 5 per cent to 5.25 per cent at its Monetary Policy Committee meeting next month, and expect rates to peak between 5.75 per cent and 6 per cent.

The scale of the fall in headline inflation could give relief to the thousands of UK households bracing for increases in their mortgage payments in the coming year.

It “will ease pressure on mortgages and wages, with the BoE less likely to keep interest rates higher for longer, and Britain’s latest 18-month pay squeeze coming to an end”, said James Smith, research director at the Resolution Foundation think-tank.

While some economists warned there have been recent false dawns on interest rates, most analysts expect inflation to continue to decline in the months ahead. The ONS data revealed that producers’ price inputs — such as parts and raw materials — contracted in June for the first time since November 2020, which could lower price pressures on business.

With the government’s energy price cap dropping in July, the direct contribution of electricity and natural gas prices to the headline inflation rate will also fall — and will drop further in October.

Added to this are falling consumer inflation expectations, rising unemployment and declining job vacancies, and impact of the BoE’s monetary policy tightening over the past two years.

“If these trends all continue, inflation should fall fast over coming months towards a 4-5 per cent rate by the end of the year and to within the 2-3 per cent range by the middle of next year,” said Kallum Pickering, economist at the investment bank Berenberg.

UK price growth remains the fastest among the G7 countries and the third highest among OECD advanced countries, however. This is in part due to the UK energy regulator’s price mechanism, which slows the rate at which the decline in wholesale gas prices passes through to household energy bills.

The UK is also experiencing a surge in job inactivity since the pandemic that has not been seen in most other advanced countries, adding to domestic price pressures. A larger reliance on food imports in the UK than in other countries is also resulting in stronger food price pressures; British food inflation slowed to 17.3 per cent in June, still nearly three times higher than in the US.

But the larger-than-expected fall in inflation reduced the difference with other advanced economies and put Britain on the same disinflationary path as most other countries.

“The UK still has one of the highest inflation rates of any advanced economy, but after today it merely looks bad rather than a basket case,” said Smith.

Source: Economy - ft.com