UK inflation fell unexpectedly in June to 2.6%, easing the pressure on squeezed household budgets and substantially reducing the likelihood of an August interest rate rise. The ONS said the drop was largely due to falling motor fuel prices, although core inflation – which strips out the more volatile components such as fuel and food – also fell, to 2.4%.
The news sent the pound sharply lower as currency traders adjusted their outlook for interest rates. The Bank of England’s rhetoric has taken an increasingly hawkish tone in recent weeks, with Mark Carney himself saying at the end of last month that “some removal of monetary stimulus is likely to become necessary”. Chief economist Andy Haldane also indicated he might support a rate rise this year. However if today’s pullback in inflation marks the start of a sustained decline, the pressure on the Bank to raise rates will ease.
Three members of the rate-setting committee voted to raise rates last month, though this includes Kristin Forbes who stepped down at the end of June.
Falling inflation alleviates the squeeze on household finances – though pay is still shrinking in real terms for now. Last week’s labour market update from the ONS showed wages growing by less than inflation for a third consecutive month. Pay (including bonuses) grew by 1.8%, meaning that after inflation, average earnings in the three-month period fell by 0.7% compared with a year earlier.
If inflation continues to moderate, this could bode well for economic growth – the UK economy is heavily reliant on the consumer, and economists had expected falling real incomes to eventually translate into lower retail sales. If this fails to materialise the economy could see a stronger second half to the year.