UK inflation jumps in June, but it won’t derail an August rate cut

UK inflation rates rose by more than expected last month. The headline rate rose to 3.6% from 3.4%, expectations were for inflation to remain at 3.4%. The core rate jumped to 3.7% from 3.5% and service price inflation defied hopes for moderation and stayed at 4.7%.  This is the highest rate for headline inflation since January 2024.

Transport costs boosts inflation

Inflation ticked up in June due to some baseline effects, for example, motor fuel fell more a year ago than it did last month, which pushed up the index. The price of food rose for the third straight month and is back at its highest level since February last year. Interestingly, UK housing costs made a downward contribution to UK inflation figures last month and the annual rate is moderating. Owner occupiers’ housing costs rose 6.4% in the12-months to June, down from the 6.7% YoY rate in May. Housing costs were one of two contributions that saw prices fall on a monthly basis between May and June this year.

Since shelter costs make up such a large part of consumer budgets, any moderation in these costs is welcomed. Transport costs were by far the biggest contribution, with smaller gains for clothing, alcohol and tobacco, recreation  and culture, and communication costs.

BOE expects bumpy road for inflation

The increase in prices is not surprising. Back in May, the Bank of England said that they saw a bumpy road ahead for inflation. The Bank expects price growth to rise to a peak of 3.7% by September, before falling again to the 2% target rate. If inflation continues to rise at this rate, then the peak in inflation may overshoot the BOE’s 3.7% estimate. However,  the BOE stated that the biggest risk to inflation was service prices remaining higher for longer. However, if we have reached peak shelter costs, then service prices could moderate in the coming months.

Rate cut expectations get scaled back

This is why we do not think that this report will shift the dial for the Bank of England, and that the Bank will cut rates as expected next month. There is still an 86% chance of a rate cut next month, down from 89% on Tuesday. However, the interest rate swaps market is now expecting just less than 2 cuts for the rest of this year, suggesting that investors are expressing some caution about the longer-term outlook for rate cuts after today’s inflation report.

The biggest market reaction has been in the pound, which has jumped back above $1.34 on this data, and the pound is the second-best performing currency in the G10 FX space so far on Wednesday. Overall, the market reaction has been moderate on the back of this inflation report. We will watch for a spike higher in UK bond yields later this morning, however, if bond investors believe that the BOE will look through this report and cut interest rates next month, then any upside in bond yields could be mild.