UK inflation data out this morning took a step lower, but marginally outperformed consensus expectations. Prices in the UK grew by 6.8% YoY in July, a significant drop from the 7.9% increase recorded in June, but one that was largely expected as an increase in the energy price cap mechanically dragged the headline number lower.
More relevant for Bank of England policymakers, core inflation failed to ease, printing in line with last month’s 6.9%.The resilience of underlying inflation in the UK economy is not unexpected, especially following resilient wage growth, a point emphasised once again yesterday in jobs data showing wages growing 8.2% 3m/YoY. But signs of the labour market continuing to cool should be some source of comfort for the BoE, suggesting that these price pressures should ease down the line. With another round of data due to be released before the September policy meeting, it is not time for the Bank of England to panic quite yet in our view.
We see today’s data as doing little to shift the needle for policymakers and continue to look for a final 25bp hike from the BoE in September, before slowing data allows for an end to policy hiking at the November meeting.
Headline inflation takes a leg lower, but not unexpectedly
Unsurprisingly, a fall in energy prices made the largest downward contribution to the change in annual CPI inflation, with the rate of YoY increase for gas, electricity and other fuels falling from 23.3% in June to just 4.5% in July. But this was somewhat offset by a jump in the contribution from rents, which increased from 5.5% in June to 6.5% YoY in July. Ultimately this meant that whilst the housing and household services components of the consumption basket produced a 0.69pp negative contribution to the change in the headline CPI rate, this was a little less than expected prior to the release. The other notable downwards contribution to the fall in CPI came from food and non-alcoholic beverages, where price growth declined from 17.3% to 14.8% in July on a YoY basis. Whilst this reduced CPI by 0.26pp, it still leaves food and as the largest contributor to overall prices growth accounting for 1.71% of the price increase of the overall consumption basket.
Underlying inflation shows signs of resilience, reflecting the strength of wage pressures
Whilst the fall in headline inflation is likely to capture many of the headlines, it is the persistence of underlying inflationary pressures that will worry the Bank of England. Core inflation was stable on a YoY basis in July, repeating the June print of 6.9%, but overshooting consensus expectations that looked for a 0.1pp drop. On a month-on-month basis this amounted to just a 0.3% increase in prices, a level only just above that consistent with the Bank of England’s inflation target, albeit this hides a significant divergence between good and services inflation. The price growth of all goods fell by 1.7% MoM in the latest release, whilst services grew by 1.0% MoM, and 7.4% YoY. The latter will be deeply concerning for the Bank of England who have identified services inflation as a key indicator for persistent inflationary pressures in the UK economy.
Notably, price growth on this metric managed to overshoot Bank staff forecasts that had only recently been updated in the August Monetary policy report.
On this note, the largest upside contribution to the annual CPI rate came from restaurants and hotels, a sector particularly exposed to rising wage pressures. This tallies with recent wage data that has shown continued and unexpected resilience, even in spite of significant monetary tightening from the BoE to date. But growing labour market slack, exemplified once again yesterday with the unemployment rate rising unexpectedly to 4.2%, should allay some of those fears, with wage growth set to cool in coming months.
Service inflation marginally overshot BoE forecasts in July, adding to fears of inflationary persistence, but a cooling labour market should ensure this does not continue indefinitely
Today’s data doesn’t change much for the BoE
Whilst today’s data does represent a small overshoot of pre-release expectations it is unlikely to change many minds at the BoE. Granted, today’s data adds to the narrative of yesterday’s strong wage figures, and therefore risks to inflation and therefore Bank Rate remain skewed to the upside. But a 0.1% upside surprise is neither here nor there for BoE policymakers this far out from the September meeting and with another set of data due to land before they have to make a decision. Instead, yesterday’s wage and labour market data are likely to hold more weight as a leading indicator for the evolution of underlying inflationary pressures. In this vein, whilst wages continue to grow faster than expected, signs of growing labour market slack should give the BoE confidence that this is unlikely to continue for much longer, even if this is yet to show up in the hard data as of yet.
Therefore, we continue to look for a rate hike at the September meeting, before cooling data allows the BoE to pause policy tightening in November with Bank Rate at 5.5%.
For markets, reaction to this morning’s data has been muted, largely reflecting the close to expectations outturn. The pound picked up by 0.2pp against both the dollar and the euro, but like policymakers, markets will likely be waiting for the next round of data before drawing any firm conclusions.
Nick Rees, FX Market Analyst