- Inflation falling significantly in July was unsurprising, given last month’s cut in energy bills. The fall in the Consumer Price Index (CPI) measure to 6.8% from 7.9% was in line with the Bank of England’s expectation. However, core inflation remained at 6.9% and services inflation rose by a bit more than the Bank of England had expected. Combined with the latest heated pay data, another rise in interest rates is looking very likely.
- That said, leading indicators point to inflation continuing to fall quickly. Both manufacturers’ input and output prices fell outright in July on a year earlier. And lower inflation and signs of a rapidly cooling jobs market should push down on pay growth. So, while Bank Rate is likely to head higher, the EY ITEM Club thinks the Bank of England will pause rate rises after one further increase.
Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “With the typical household energy bill falling by almost 20% in July and petrol prices stable on the previous month versus a sizeable rise in July 2022, a substantial fall in inflation had been on the cards. In practice, a fall in the CPI measure to 6.8% from 7.9% in June was in line with the consensus of forecasters and the Bank of England. However, core inflation, which excludes the volatile energy and food components, was unchanged at 6.9%. And services inflation, the Bank of England’s go-to indicator of domestically-generated price pressures, rose to 7.4% from 7.2%. The Bank of England had expected services inflation to increase, but only to 7.3%.
“Continued stickiness in core and services inflation is likely to add to the Bank of England’s caution following the latest pay data, which showed growth in wages rising to record, or near-record, highs on many measures. Another rate rise when the Bank of England’s Monetary Policy Committee (MPC) meets next in September is looking increasingly likely.
“However, the EY ITEM Club thinks the MPC will stick to a standard 25bps increase in Bank Rate, rather than going bigger, and that a rise next month could prove the last in the current cycle. The latest leading indicators of inflation point to price pressures continuing to ease quickly. Year-on-year growth in the price of raw materials and other inputs used by manufacturers fell deeper into negative territory in July and factory gate prices also declined outright for the first time since December 2020. And another likely fall in energy bills in October should add to the downward pressure on inflation.
“Meanwhile, a surprisingly large rise in unemployment, alongside falls in employment and jobs vacancies, points to a rapid cooling in the jobs market, which should weigh on pay growth over time. Falling inflation expectations should have the same effect.
“The uncertainty is whether, and when, the MPC will place a keener focus on future prospects for inflation, rather than setting policy largely on the basis of past data. In the EY ITEM Club’s view, that point has not been reached yet. But the fact that another set of pay and inflation numbers will be released before the MPC meets next month means the outlook for monetary policy is not yet set in stone.”