UK inflation sees downside surprise, but Bank of England still on hiking path

Consumer Price Index (CPI) fell to 7.9% year-on-year in June from 8.7% - consensus expectations were for a fall in headline inflation to 8.2% and marks the first downside surprise since January.

Annual core inflation fell from 7.1% to 6.9% (consensus: 7.1%). Retail Price Index (RPI) was lower than expected too at 10.7% after 11.3% (consensus: 10.9%).

The largest downward contributions to the fall in headline CPI inflation were energy prices (again) and food inflation fell again too. The fall in core inflation looks to have been driven by the furniture and household goods category (the kind of category where I’d expect to see some downside pressure from earlier easing in general global supply chain problems and lower energy price inflation) and restaurants/hotels (specifically accommodation services).

These movements will reflect a mixture of things, though this downside surprise doesn’t look as ‘noisy’ as last month’s upside surprise, with potentially volatile items like air fares, live music events and computer games not seeming to play a key role this time. The fall in energy price inflation still has some way to go on my forecasts, with powerful negative base effects and falls in electricity/gas bills likely to pull headline inflation down even further this year (my forecasts at the moment have CPI inflation averaging close to 4.5% in the last quarter of this year). I’d expect core CPI inflation to follow falls in energy and food inflation lower with a lag and today’s move makes directional sense in that context.

Domestically-driven inflation still looks strong though. Six of the twelve main sub-categories made neutral or upward contributions to this month’s change in CPI inflation. Services inflation slowed (a little) to 7.2% from 7.4%, but that’s clearly still a very high rate of inflation. It was again striking how little downward pressure you can see across services components generally. Inflation in housing services was stable, as was the miscellaneous services category and travel/transport services (buoyed by 47.9% inflation in transport insurance), communication services inflation was stronger.

Recreation and personal services inflation did fall though, driven especially by package holiday/accommodation services (though that still ran at 11.8%). CPI figures by import-intensity will come out later this morning, but as of the May data, the CPI contribution from least import-intensive (most ‘domestic’) bits of inflation remained well above average. Pay growth remained strong on the data released last week too of course, though the labour market figures overall were consistent with a less tight labour market...

Bank of England (BoE) still likely to hike further: The BoE have continued to signal that if inflation pressures prove persistent then they will likely tighten monetary policy further. The May BoE staff forecast for the June 2023 CPI figure was 7.9%, hence this figure brings the figures back in line with those forecasts from the May Monetary Policy Report after last month’s overshoot. In the context of still strong domestic inflation pressure, however, I’d expect them to hike rates 25bps in August (though that could have been 50bps had we seen another big upside surprise today). One downside surprise in the CPI figures is unlikely to be enough to make the BoE feel confident that UK inflation is sustainably heading back to their 2% target. A 25bps hike in August is probably not going to quite mark the peak either. Consensus expectations of a 5.75% peak look fairly reasonable for now (from 5.00% currently), absent a few more downside surprises like this and more evidence that the labour market is getting substantially less tight.

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