Confusing UK interest rate outlook

author: FutureCar Staff    

British households are facing a confusing time as inflation figures show a slight decrease in the Consumer Price Index (CPI) for the 12 months to July. The CPI stood at 6.8% compared to 7.9% the previous month. However, core CPI, which excludes energy costs and food, remained unchanged at 6.9%. Despite the slight decrease, core inflation remains high, leading many economists to believe that the Bank of England will not be lowering interest rates anytime soon. The battle against inflation is far from over.

The drop in inflation can be attributed to falling gas and electricity prices in July. This downward pressure on inflation was countered by high food prices, although food price inflation eased for items such as milk, bread, and cereals. The CPI all goods index rose by 6.1% in the year to July, down from 8.5% in June. However, the CPI all services index increased to 7.4% in the year to July. This increase was driven by rising prices in hotel rooms and restaurants, where annual inflation stood at 9.6%.

While it cost less to fill up the car with petrol for a staycation in July compared to last year, the price of hotel rooms and accommodation services rose by 12.2% in the year to July. Utility bills and food prices were the main drivers of slower headline inflation, but inflation in domestically-generated services, such as hotels, remained strong. Overall, the inflation numbers indicate a slight improvement, but many economists are concerned about the tightness in the labor market and its impact on core CPI.

The tightness in the labor market is feeding demand and keeping core CPI "sticky." Average wages, excluding bonuses, grew by a record 7.8% in the second quarter of 2023 compared to a year earlier. While falling inflation is welcome news for households, the Bank of England has made it clear that they are willing to keep interest rates higher for longer to rein in price pressures. Financial conditions for households and businesses are expected to remain tight for the foreseeable future.

In the mortgage market, lenders have been trimming rates on their mortgage offerings following the larger-than-expected fall in June inflation numbers. However, the mixed messages in the inflation data may spook markets, potentially leading to steady or slightly increased mortgage rates. There is also concern about the mortgage shock when many mortgage-holders come to the end of their fixed-rate mortgages. Renewing their mortgages over the next 12 months could make them on average £3,456 worse off each year.

Prime Minister Rishi Sunak promised to halve inflation by the end of 2023. However, the stubbornness of core inflation and strong wage growth within a tight labor market cast doubt on his ability to keep this promise. Falling energy prices were expected to contribute to the decrease in inflation, but the high rate of inflation for goods and services other than food and energy has put the target in jeopardy. The Bank of England still faces challenges in taming price pressures and meeting its 2% inflation target.

Financial markets have already priced in further increases to interest rates, with the Bank of England's monetary tightening cycle expected to peak in February next year. Core inflation remains a concern, particularly in the services sector where high wages growth is observed. Despite the slight decrease in inflation, households are unlikely to see much relief as there is still significant demand in the economy. Balancing inflation promises with potential risks to the economy remains a challenge for policymakers.

FutureCar Staff