UK inflation softens to reduce BoE rate hike pressure

UK consumer price inflation unexpectedly eased back last month, according to official figures released on Tuesday, with economists disagreeing over whether this is a false dawn.

The consumer price index was 2.6% higher in June than the same month last year, the Office for National Statistics revealed, softening from the 2.9% rate in May.

Most economists had expected the headline rate of CPI to remain roughly the same or at least only shrink to 2.8%, although the number was in line with the Bank of England’s latest forecast.

Month on month CPI was flat in June, when it was forecast to ease to 0.2% from the 0.3% rate a month before.

Core CPI, which strips out more volatile prices such as fuel and food, softened to 2.4% from the 2.6% at which it was predicted to remain.

CPIH, the ONS's newly preferred measure of inflation as it includes owner-occupiers' housing costs, dropped back to 2.6% from the prior month's 2.7%, where it was forecast to stay.

Petroleum products were mainly behind the drop in the annual growth rate of factory gate prices, ONS said, with crude oil mainly responsible for the recent slowing of input price inflation, with both its dollar price down and some recovery in sterling, while the change in core CPI reflected a fall in toys and games prices.

The acceleration of UK inflation in 2017 has been under intense scrutiny by both cash-strapped consumers and rate-setters at the Bank of England, with households suffering a squeeze as CPI accelerates past earnings growth, which last week was revealed to have slowed to 1.8% in the three months to June from 2.1% a month before.

This means real earnings remain sharply negative, with average earnings in the three months to June down by 0.7% compared with a year earlier.

Although the Monetary Policy Committee are confident inflation will not overshoot stuttering earnings growth for too long, their last meeting saw a 5-3 split vote in favour of raising rates due to concern about spiking prices.

BoE Governor Mark Carney said at the end of last month that "some removal of monetary stimulus is likely to become necessary" and chief economist Andy Haldane indicating he might support a rate rise later this year.

REACTION AND ANALYSIS

Tuesday morning's easing inflation lowered the likelihood of an imminent rate rise and sent the pound sharply lower as currency traders adjusted their outlook for interest rates.

Do not be fooled into thinking the fall in CPI inflation in June is a sign that the impact of sterling’s depreciation already has been fully felt, warned economist Sam Tombs at Pantheon Macroeconomics, as he predicted both food and core goods inflation still have further to climb in response to the weakening of the pound.

With rises still coming through the system for core goods and food, plus EDF Energy’s price rise in late June and British Gas expected to hike prices soon after its price freeze ends in August, he expects CPI inflation to exceed 3% in Q4, just.

Although it was CPI's largest monthly drop since February 2015, "this is unlikely to mark a turning point", agreed Capital Economics' Ruth Gregory, who also sees further increases at the end of 2017 as likely.

"While further rises are probably in prospect, CPI inflation should now not be too far away from its peak," she said, with the effects of sterling’s slide appearing to be fading as producer input price inflation fell from 11.6% in May to 8.8% in June, while output price inflation dropped from 3.6% to 3.3%.

"So while we still think that CPI inflation will reach a peak of about 3% towards the end of 2017, it seems likely to drop back pretty quickly in 2018. All in all, then, this provides further evidence that the squeeze on consumers’ real incomes will probably be nowhere near as large, or as long-lasting as it was after sterling’s last major depreciation in 2008."

An August rate hike does look highly unlikely now, said analyst Neil Wilson at ETX Capital, "but we should remember that the Bank has only limited tolerance for continued above-target inflation and may yet seek to push rates back up to 0.5% this year, if conditions in the wider economy improve whilst inflation remains above 2%.

"With pressures on consumers, slacker inflation is a good sign for aggregate demand so this may yet support conditions for a rate hike," he said.

Economist Ben Brettell at Hargreaves Lansdown was optimistic.

He added: "If inflation continues to moderate, this could bode well for economic growth – the UK economy is heavily reliant on the consumer, and economists had expected falling real incomes to eventually translate into lower retail sales. If this fails to materialise the economy could see a stronger second half to the year."