June’s Inflation rate in the UK fell to the lowest level since March of 2022, according to the Office of National Statistics (ONS) report. June’s consumer price inflation saw the slowest growth in more than a year at 7.9% compared to the expected 8.2%.
The core inflation rate, which removes the volatile components of energy, food, tobacco, and alcohol, also fell to 6.9%, below the expected 7.1%. The data was seen as easing some pressure on the Bank of England (BOE) to keep up its sharp interest rate increases despite annual inflation remaining well above the bank's target of 2%.
Pound Reacts in Response
In light of the lower inflation release, the pound weakened against major peers such as the dollar and euro. GBP/USD (GBPUSD) fell 0.6% on Wednesday as of the time of the writing, while EUR/GBP (EURGBP) lost 0.7%.
The FTSE 100 (UK100) jumped as much as 1.2% in the immediate aftermath on Wednesday, led by homebuilders and real-estate-related firms, as investors wagered that borrowing rates in the UK will not rise as much, mainly supported by homebuilders and landlord stocks. The homebuilders' index rose almost 7%, the biggest jump since the end of 2008, while the index of landlord firms rose nearly 6%. Interest rate futures showed investors now see interest rates peaking below the 6% expected prior.
A Closer Look at the Numbers
The ONS chief economist, Grant Fitzner, said fuel prices were the biggest drivers for the drop in inflation. Food inflation was still high at 17.3% but down from the 18.7% recorded in May, with the reduction also contributing to the positive data for the BOE. Despite manufacturers continuing to incur high costs, costs for raw materials saw the first decline since the end of 2020.
In reaction to the data, Chancellor Jeremy Hunt doubled down on the government's commitment to halve inflation by the end of the year. Analysts point to the possibility that energy and food inflation might be shifting around, hence making it possible to get inflation closer to 5% before 2024. However, other analysts cautioned that the inflation rate was still way above the BOE’s target in order for it to consider a pause in its multi-year hiking path.
Implications for Monetary Policy
The lower inflation is seen as potentially convincing the Monetary Policy Committee (MPC) members to hike by 25bps when it meets on August 3. However, analysts say that the BOE will also look at other data, such as wages and the renewed slowing down in the jobs market. This could mean that the BOE could consider bringing forward its expected rate hike in September and once again hike by 50bps.
Markets are now showing a 25 bps hike is more likely than the 50 bps hike, which was priced last on Tuesday, July 18. The BOE has expressed concern in the past that the strong growth in wages would keep inflation higher for longer than it forecasted and would mean that the CPI wouldn't come down to the 5% before the end of the year as expected. The BOE sees inflation returning to its target of 2% by early 2025. (Source:Yahoo Finance)
What Could It Mean for the Future?
The drop in the British pound may be a reflection of the shift in market expectations towards fewer interest rate hikes. The UK still has the highest inflation among its G7 peers. In fact, inflation has taken longer to fall in the UK than in other countries, partly because of how energy subsidies are repriced every six months.
Moreover, it is believed that the BOE will likely raise rates again at its August meeting, with a quarter of a point of interest rate increase expected as of the time of writing. Analysts point towards the drop in services inflation as potentially being enough to convince members of the MPC to end the hiking cycle as soon as November. That would point to an interest rate peak within the 5.50-5.75% range compared to 6.15%.
UK inflation fell more than expected in June, hitting the slowest rate of increase in over a year. The pound slid against the dollar and euro as markets now show that a 25 bps hike is more likely at the next BOE meeting than the 50 bps hike that had been priced in until recently.
The UK benchmark FTSE 100 rose by 1.2% following the data release, led by stocks related to the property sector. Will investors be surprised, or will the BOE continue to raise rates to record a 14-meeting hiking steak?