In the City, investors are rethinking how high the Bank of England will need to raise interest rates, now that inflation has dropped by more than expected to a 15-month low of 7.9% in June.
The money markets now think there is a 65% chance that the Bank only raises rates by a quarter-point, from 5% to 5.25%, at its meeting in early August.
A larger, half-point, hike next month is seen as a 35% chance.
Last night, the odds were the other way around – with a half-point rise seen as a 58% chance (as flagged earlier).
Looking further ahead, UK interest rates are now seen peaking at around 5.8% in February 2024, down from around 6% yesterday.
Earlier this month, the markets had priced in rates rising as high as 6.5% by March.
Mohamed El-Erian, chief economic advisor to Allianz, says this is good news for mortgage holders.
Paul Dales, chief economist at Capital Economics, says:
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 services 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%.
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Shares are rallying strongly in the City, as traders cheer the larger-than-expected drop in UK inflation to 7.9% inJune.
The blue-chip FTSE 100 index hit its highest level since 21 June in early trading, and is currently up 93 points or 1.2% at 7,547 points.
Housebuilders are among the top risers, reflecting hopes that interest rates will not be raised to 6% or higher as feared.
Barratt Development, Persimmon and Taylor Wimpey have all jumped around 5%, helped by the falling expectations for UK interest rate rises.
Victoria Scholar, head of investment at interactive investor says:
“European equities have opened in the green and the FTSE 100 back above 7,500 with UK inflation figures in focus.
Housebuilders are at the top of the UK index, hitting a one-month high, thanks to a softer-than-expected CPI reading.
The FTSE 250 index, which contains smaller companies and is more UK-focused, has surged by around 2.5% this morning with nearly every stock rallying.
Traders will be hoping that the Bank of England does not need to hike borrowing costs as fast as feared, meaning less damage to the UK economy.
June’s drop in inflation will “fuel a narrative that we are through the worst” of the cost of living squeeze, says Kitty Ussher, chief economist at the Institute of Directors:
“However, core inflation has only eased slightly. The Bank of England will also be concerned that inflation in the services sector is proving relatively persistent….
The Bank of England will hope that this will cause business leaders and others to lower their expectations of future inflation, which could then become self-fulfilling.”
Despite June’s drop to 7.9%, the UK still has a much worse inflation problem than other advanced countries.
In the US, for example, inflation fell to 3% in June, while in the eurozone it is estimated to be 5.5% (we get updated data at 10am BST).
This gap has been blamed on the UK suffering from both Europe’s surge in energy costs, and also labour shortages similar to the one which hit the US.
Grant Shapps, the Secretary of State for the Department for Energy Security and Net Zero, has welcomed the drop in UK inflation to 7.9% this morning.
He told BBC Radio 4’s Today programme that inflation was effectively a tax on households and businesses:
“I think we have to stay the course and I welcome the drop this morning, 7.9%.
But of course, that’s still prices 7.9% higher than they were a year ago. This is a very important, significant, effectively tax on households and businesses in this country.
And we want to see it continue to fall. So we’re going to carry on following the plan, which is now working, we’ve come down from 11.1% I think at its peak, and make sure that we support the process, support the bank in the work that they’ve been doing. But also things like the energy price guarantee over the winter were big supports. We’re now seeing energy prices fall and that’s leading to lower inflation as well.”
Shapps added that nine other EU countries had higher inflation rates than the UK.
He also poined to the tight UK labour market as one factor pushing up inflation:
“I think our uniqueness in Europe has been, one of the key aspects has been, we’ve got both the threat that Putin posed from using energy as blackmail, but also incredibly low, tight employment market in the UK, where unemployment is so low, and in fact, we have record numbers of people in work.
So I think that’s made our inflation stickier, but very good to see it come down today.”
Finally, we have some good news on UK inflation. says James Smith, developed markets economist at ING.
Smith writes:
Headline CPI has dropped back to 7.9%, below consensus and almost a full percentage point lower than in May.
Much of that can be put down to petrol and diesel prices, which fell by 2.6% across the month – a stark difference to the same period last year, where we saw a near-10% spike amid the ongoing fallout of the Ukraine war.
But encouragingly, we also saw a marked slowdown in food inflation.
These prices increased by 0.4% on the month, which looks like the slowest month-on-month increase since early 2022. This is a trend that should continue, given that producer prices for food products are now falling on a three-month annualised (and seasonally-adjusted) basis.
Smith says the August Bank of England meeting is “going to be a close call”, but today’s data makes a 25bp hike (a quarter of one percentage point) more likely than a repeat 50bp increase.
He explains:
The Bank will also be looking at the recent wage data, which was stronger than expected but came alongside figures showing a renewed cooling in the jobs market and improvements in worker supply.
The risk is that the BoE applies a similar logic to that seen in June. This could mean that if it expects to hike again in September, then it might as well opt for a larger 50bp hike in August. We certainly wouldn’t rule this out.
In further good news on inflation, UK producers have slowed their price rises.
The ONS reports that prices at the factory gate only rose by 0.1% in the year to June, down from 2.7% in the year to May.
Producers benefited from cheaper raw materials – their input prices fell by 2.7% in the year to June 2023, led by cheaper crude oil and petroleum products.
On a monthly basis, producer input prices fell by 1.3% and output prices by 0.3% in June.
Hopefully retailers will pass this onto consumers, otherwise accusations of ‘greedflation’ and profiteering will grow louder.
Here’s a breakdown of how prices changed in June, year-on-year, pulling inflation down to 7.9%.
Food and non-alcoholic beverages: prices rose by 17.3% in the year to June, down from 18.3% in the year to May
Alcoholic beverages and tobacco: prices rose by 9.2% per year, down from 9.3% in May
Clothing and footwear: prices rose by 7.2%, up from 7.1% in May
Housing, water, electricity, gas and other fuels: prices rose by 12%, down from 12.1% in May
Furniture, household equipment and maintenance: prices rose by 6.5%, down from 7.5% in May
Health: Prices rose by 8.2%, down from 8.3% in May
Transport: prices fell by 1.8%, down from a 1.2% rise in May
Communication: Prices rose by 9.5%, up from 9.1% in May
Recreation and culture: Prices rose by 6.7%, matching May’s reading
Education: Prices rose by 3.2%, matching May’s reading
Restaurants and hotels: Prices rose by 9.5%, down from 10.3% in May
Miscellaneous goods and services: prices rose by 6.5%, down from 6.8% in May
On a monthly basis, consumer prices rose by 0.1% in June.
That’s a slowdown on May, when prices rose by 0.7% month-on month.
Consumer prices have been rising on a monthly basis since February this year, as this table shows, which has kept the annual rate of inflation (prices compared to a year ago) high:
In the City, investors are rethinking how high the Bank of England will need to raise interest rates, now that inflation has dropped by more than expected to a 15-month low of 7.9% in June.
The money markets now think there is a 65% chance that the Bank only raises rates by a quarter-point, from 5% to 5.25%, at its meeting in early August.
A larger, half-point, hike next month is seen as a 35% chance.
Last night, the odds were the other way around – with a half-point rise seen as a 58% chance (as flagged earlier).
Looking further ahead, UK interest rates are now seen peaking at around 5.8% in February 2024, down from around 6% yesterday.
Earlier this month, the markets had priced in rates rising as high as 6.5% by March.
Mohamed El-Erian, chief economic advisor to Allianz, says this is good news for mortgage holders.
Paul Dales, chief economist at Capital Economics, says:
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 services 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%.
Shadow chancellor Rachel Reeves points out that an inflation rate of 7.9% still means prices are rising at ‘staggering rates’.
That’s an important point – falling inflation does not mean prices are falling (just that they are rising less rapidly).
Reeves says:
“Inflation has been persistently high and remains higher than our international peers. This is becoming a hallmark of Tory economic failure.
“Today’s numbers confirm what families across the country already know – that prices are still going up at staggering rates and that they’re bearing the brunt of those costs.
“There may be global shocks – but Britain is so exposed to those because of Tory economic failure that has led to a severe lack of security in our economy.
“Only Labour has the plans Britain needs to put our economy on a more secure path – so that families are better off and so we can grab hold of the opportunities of the future.”
Jeremy Hunt has said the government was not complacent about inflation, after it dropped to a 15-month low of 7.9% in June.
The chancellor says:
“Inflation is falling and stands at its lowest level since last March; but we aren’t complacent.”
Cheaper petrol and diesel at the pumps helped to pull inflation down last month.
Today’s inflation report shows that motor fuel prices fell by 22.7% in the year to June 2023, compared with a fall of 13.1% in May.
The ONS explains:
Average petrol and diesel prices stood at 143.0 and 145.7p per litre respectively in June 2023, compared with 184.0p and 192.4p per litre in June 2022.
Petrol prices fell by 1.4p per litre between May and June 2023, compared with a rise of 18.1p per litre between the same two months a year ago
Similarly, diesel prices fell by 8.9p per litre this year, compared with a rise of 12.7p per litre a year ago.
Sterling has dropped sharply in the foreign exchange markets, as investors react to the drop in UK inflation in June to 7.9%.
The pound has lost almost a cent against the US dollar to $1.2940, down from $1.3034 last night.
That suggests the City are expecting that fewer increases in interest rates may be needed to cool UK inflation….
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2023-07-19 06:42:54Z
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