UK Inflation Falls Below 8% for First Time in Over a Year

Britain’s inflation rate dropped to the lowest in 15 months, fueling hopes among investors and economists of a shift away from the worst price spiral in the Group of Seven nations.

(Bloomberg) — Britain’s inflation rate dropped to the lowest in 15 months, fueling hopes among investors and economists of a shift away from the worst price spiral in the Group of Seven nations.

Official data showed that annual consumer price growth cooled sharply to 7.9% in June from 8.7% the previous month, marking the first time in five months that the headline reading came in lower than expected. Underlying pressures also retreated from their highest in three decades.

Markets pared back bets for sharp increases in interest rates following the data, ruling out scenarios where the Bank of England would have to push borrowing costs near 7% by the end of this year. 

It’s a relief for BOE Governor Andrew Bailey and Prime Minister Rishi Sunak, who were feeling the heat from the struggle to get a grip of the worst cost-living crisis in generations. It could also ease the pressure on homeowners after a sharp surge in mortgage rates that threatened to be politically damaging for Sunak.  

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, called the figures “a watershed moment.”

“We continue to think that the worst is over for UK households and that the MPC will not need to raise Bank Rate all the way to 6.25%, as markets priced-in yesterday,” he said.

Sunak has staked his economic reputation on halving the inflation rate by the end of the year ahead of a general election widely expected next year. 

Britain remains an international outlier, with prices still rising almost four times the BOE’s 2% target in contrast to the US, where headline CPI has dipped back to 3%. However, Wednesday’s data brings the UK closer to international peers and even bucked an reacceleration in core prices seen in the eurozone in June.

What Bloomberg Economics Says …

“The unexpected slowdown in core inflation in June will probably be enough for the Bank of England to favor a 25 basis-point hike at its August meeting — but the decision is likely to be finely balanced. With underlying price pressure set to ease only slowly over the remainder of the year, we think the central bank is on course to hike rates again in September and November.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.

Investors now expect rates — currently at 5% — to peak at below 6% with another half percentage point at the BOE’s August meeting in doubt. The sharp moves on markets will dampen fears of a major mortgage crunch that threatened to tip the UK economy into recession after a recent surge in borrowing costs.

Hussain Mehdi, macro investment strategist at HSBC Asset Management, said the figures are “tentative evidence that UK inflationary pressures might finally be turning a corner.”

“Although inflation remains well above the 2% target, the direction of travel is now looking more favorable, following a period when UK inflation appeared to be very sticky in comparison with other economies,” said Martin Beck, chief economic adviser to the EY ITEM Club.

The Office for National Statistics said falling prices at the pumps for motorists and a smaller increase in grocery bills drove the drop in the inflation rate.

Most encouraging for the BOE were signs of domestically generated inflation beginning to ease. Core inflation — which strips out volatile food and energy prices — dropped for the first time in five months to 6.9% and there was also a cooling in services price increases, a measure the BOE has highlighted as important to its thinking. Inflation is set to fall even further in July’s data as the UK’s energy price cap limiting bills for households will fall.

The data caused sharp moves on markets that could relieve some of the pressure on homeowners after a surge in mortgage rates in recent months.

The market now sees the key rate peaking below 6%, down from as high as 6.5% priced earlier this month. The odds of a half-point hike in August — almost fully priced before the release — dropped to one in two. 

The yield on two-year interest rate swaps, which are used to price mortgages, sank over 20 basis points to 5.5%, falling further from the peak of above 6.3% hit earlier this month. It could suggest that the jump in mortgage costs that threatened to dampen household confidence and weaken the UK economy will ease. Shares in housebuilders headed for their best day since 2008 on hopes of a rebound in the property market, helping the FTSE 100 climb 1.4% in morning trade.

Gilts soared, sending the yield on the two-year note more than 20 basis points lower to 4.86%, putting it on course for its biggest drop since March. The pound fell 0.8% versus the dollar to $1.2934.

“You could almost hear the sigh of relief at the BOE,” said Valentin Marinov, head of G-10 currency research at Credit Agricole. “As a minimum, the UK rates investors could reconsider their expectations of a 50bps hike in August and may even reassess the expectation of 6% terminal rate.”

It came as new research laid bare the impact of higher interest rates on companies. The number of profit warnings by UK-listed firms rose for the seventh consecutive quarter in the three months to June, according to a report by Ernst & Young’s strategy consulting arm EY-Parthenon.

However, economists warned that the BOE is likely to press ahead with some interest rate rises.

Yael Selfin, chief economist at KPMG UK, said the Bank of England was “unlikely to substantially change its hawkish policy stance” as inflation was still well above target.

“Inflation is unlikely to return to target before early 2025,” she said. “We expect inflation to average 7.5% this year before falling to 3% in 2024.”

Slowing inflation is a relief for consumers, who have been struggling with food and energy costs, as well as a spike in mortgage rates. It also helps Sunak ahead of key special elections on Thursday. The Conservative government lags far behind the Labour opposition in national opinion polls and has promised to cut the pace of price increases in half this year from the 10.5% reading at the end of 2022. 

“Inflation is falling and stands at its lowest level since last March,” Chancellor of the Exchequer Jeremy Hunt said in a statement. “But we aren’t complacent and know that high prices are still a huge worry for families and businesses.” 

There were further signs of pipeline price pressures easing, which officials hope will be soon be passed on by retailers. Producer input prices fell a larger-than-forecast 1.3% on the month amid a drop in oil and commodity prices. They were down 2.7% from a year earlier, the first negative annual reading since November 2020.

The price of goods leaving factory gates fell 0.3%, leaving them up just 0.1% on the year.

–With assistance from Greg Ritchie, Philip Aldrick and Alice Gledhill.

(Updates with context and comment from the first paragraph.)

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