In the City, investors and economists are now wondering whether the Bank of England (BoE) will become less aggressive and whether it will raise interest rates less sharply than anticipated after inflation dropping to 7.9% in June.
Sterling dropped sharply, indicating that investors are now expecting fewer increases in interest rates to tame inflation.
The marketbelieves there is a 65% chance that the Bank will raise rates from 5% to 5.25%, at its next meeting in early August. There is also a 35% chance for a larger, half-point hike.
Looking ahead, interest rates in the UK are now anticipated to peak at around 5.8% in February 2024.
Paul Dales, chief economist at Capital Economics, explained:
“Overall, the UK will probably still have higher rates of inflation than elsewhere for a while yet, but at least the UK is now following the global trend. Our forecast is that core and ser vices CPI inflation will both ease gradually as the effects of the previous rises in interest rates are felt. But with wage growth and services CPI inflation both currently stronger than the Bank had expected back in May, we think there is enough evidence of ‘more persistent pressures’ to prompt the Bank to raise interest rates a little bit further than we previously thought. Even so, we think rates are more likely to peak between 5% and 6% than between 6% and 7%.”
Inflation rate details
The UK inflation rate fell more than expected in June to 7.9%, which has helped alleviate market concerns about aggressive interest rate hikes. The Office for National Statistics reported a downward trend in the annual inflation rate, which has led markets to believe that the BoE won’t raise interest rates above 6% early next year.
What has helped cool inflation?
The recent drop in inflation was driven by a significant fall in the price of petrol and diesel. Their prices fell by over 20% compared to last year when prices were at record highs. Additionally, mortgage holders may find some relief as markets now expect that the central bank will slow down its aggressive rate hiking path and go for a smaller quarter-point rate hike.
Remaining challenges and government response
Despite the decline in inflation, the UK still maintains one of the highest inflation rates among the G7 group of advanced economies, significantly surpassing the Bank’s official 2% target. The cost of living crisis has been exacerbated by the BoE’s consecutive 13 interest rate hikes.
Chancellor Jeremy Hunt has acknowledged the ongoing concerns for families and businesses due to high prices and has committed to halve inflation this year. Hunt hailed the latest inflation figures, but he said there was a long way to go to tackle inflationary pressures. Speaking on BBC Radio 4’s Today programme, Grant Shapps, the Secretary of State for the Department for Energy Security and Net Zero, has also welcomed the drop in inflation. He emphasised that inflation needs to continue falling and the government will ensure to support the process and the bank in its difficult task. He clarified that inflation was exacerbated by Putin’s use of energy as blackmail, but also the UK’s tight employment market with low unemployment and high number of people in work.