UK inflation surprise fuels rate hike speculation

UK inflation surprise fuels rate hike speculation

According to data from the Office for National Statistics (ONS) the UK returned to inflation in July, with average prices up 0.1% compared to the same period last year.

This is contrary to market expectations, with the majority of analysts predicting that inflation would remain at 0% in July, as it was in June.

The ONS says that a smaller fall in the price of clothing compared to last year helped to boost inflation, with prices down 3.4% between June and July this year compared to a decline of 5.7% between the same two months a year ago.

Transport services, recreation and culture, and miscellaneous goods and services also helped to boost prices, with higher air fares, the increased cost of toys and games and a surge in bank overdraft charges all contributing to consumer prices index (CPI) growth.

Core surprise

As has been the case for a number of months the falling cost of fuel and food dragged the annual rate down, as a much lower oil price compared to a year ago and the supermarkets' ongoing price war continue to have a negative impact.

However, stripping out the effects of energy and food, UK core inflation rose from 0.8% in June to 1.2% in July. Again, this figure beat analysts' expectations for core inflation to remain at 0.8%.

Commenting on the rise in core inflation, Ben Brettell, senior economist at Hargreaves Lansdown, says: "The rise in the core figure suggests that underlying inflationary pressures could be building in the economy, and is possibly the clearest indication yet that the Bank of England might have to raise interest rates sooner rather than later.

"Currency markets seem to agree - sterling jumped around a cent against the dollar, and almost a cent against the euro immediately after the figures were released."

Maike Currie, associate investment director at Fidelity Personal Investing, agrees with Brettell, adding that markets will be watching the Bank of England's next announcement closely.

Turning tide

"The tide could be turning on the era of ultra-low rates. Earlier this month, the Monetary Policy Committee (MPC) minutes showed one member, Ian McCafferty, voted in favour of an interest rate hike. The next minutes could provide some telling insight on whether Carney's vision of a gradual trot towards higher interest rates will in fact turn into a faster gallop," she says.

However, Samuel Tombs, senior economist at Capital Economics, warns against over-enthusiasm, arguing that inflation is likely to remain low for some time: 'Looking ahead, the scale of the recent fall back in oil prices suggests that CPI inflation is still likely to turn negative again over the next few months.

"And while inflation should pick up at the start of 2016 as the anniversary of the plunge in oil prices is reached, pipeline price pressures remain extremely weak while long time lags between changes in import prices and shop prices mean that sterling's recent appreciation will keep a lid on CPI inflation until the end of 2016."

Tombs adds that the inflation outlook is still "too weak" for the MPC to justify raising interest rates this year, with a hike more likely to come in the second quarter of 2016.

This article was written for our sister website Money Observer

More about