British inflation pressures stay hot, reducing chance of August rate cut

British inflation defied forecasts for a slight fall and held at 2 per cent in June while strong underlying price pressures prompted investors to reduce bets that the Bank of England will cut interest rates in two weeks’ time for the first time since 2020.

Increases in hotel prices - in a month when US pop star Taylor Swift and other performers toured the UK - were partly to blame for the higher-than-expected inflation number, underscoring the BoE’s concern about services prices.

Britain’s once-towering headline inflation is lower than in the United States and the euro area after past jumps in food and energy prices fell out of the numbers. But core inflation is higher and the Bank of England (BoE) is unlikely to take much comfort from the latest figures.

“If an August rate cut was ‘touch and go’ before this morning’s data then it’s even more so now,” Cathal Kennedy, senior UK economist at RBC Capital Markets, said.

Economists polled by Reuters had mostly expected headline consumer price inflation would ease to 1.9 per cent in the 12 months to June, extending its drop from a peak of 11.1 per cent in October 2022.

Inflation for services was 5.7 per cent, the Office for National Statistics said, unchanged from May. The Reuters poll had pointed to a slightly weaker 5.6 per cent increase.

Investors pared back bets on a BoE rate cut on Aug.1, the date of its next scheduled monetary policy announcement, to about 35 per cent, down from just under 50 per cent before the data.

The pound hit its highest for nearly two years against the euro and around one year against the dollar, rising above $1.30.

The BoE took comfort from May’s fall in consumer price inflation to its 2 per cent target for the first time in nearly three years. But it has expressed concern about the strength of services inflation, which largely reflects pressure from wage growth in a labour market short of candidates to fill jobs.

Deutsche Bank chief UK economist Sanjay Raja said the hotel prices increase might reflect the Taylor Swift tour. Although this rise could well reverse in July’s data, overall Wednesday’s inflation numbers would not be encouraging for the Bank of England.

“We now think that an August rate cut is finely balanced. A lot will now depend on the strength of the May wage and unemployment data,” he said.

Data due on Thursday is expected to show wages are still rising by almost 6 per cent a year - roughly double the rate that would be compatible with keeping inflation at 2 per cent.

An interest rate cut on Aug. 1 would give an early boost to new Prime Minister Keir Starmer and his finance minister Rachel Reeves after a landslide election victory two weeks ago.

The new government’s legislative agenda - including its plans to boost economic growth - is due to be announced in parliament later on Wednesday.

But last week the Bank of England (BoE’s) Chief Economist Huw Pill said the timing of the first rate cut remained an open question. On Tuesday, the International Monetary Fund’s chief economist, Pierre-Olivier Gourinchas, said services inflation in Britain, like in the United States, was likely to prove sticky.

Core inflation - excluding volatile food and energy prices - held at 3.5 per cent in the 12 months to June, the ONS said, matching the median forecast in the Reuters poll.

The BoE had expected headline inflation of 2.0 per cent in June and services inflation of 5.1 per cent, according to forecasts it published two months ago. The BoE also expected headline inflation to rise back above its target later this year and through 2025.

The ONS said upward pressures on headline inflation in June included a smaller fall in the costs of second-hand cars than in June last year, as well as the increase in hotel prices.

Some analysts pointed to a fall in service price inflation in June if volatile items such as hotel prices are excluded.

The ONS used 56 price quotes to measure hotel inflation in June with two of them raising prices by 176 per cent and 145 per cent from May. One of those two was located in northwest England shortly before Swift performed in Liverpool, accountant and data analyst Peter Donaghy said on X.

Clothing prices fell as retailers resorted to discounting to entice shoppers still feeling the impact of a cost-of-living squeeze and wetter-than-usual summer weather.