‘Surprise’ drop in inflation: Commentary

• Inflation in the UK dropped to 7.9% in the year to June, according to the Office for National Statistics

• Today’s figures came as a positive surprise to some, as economists had expected a smaller drop to 8.2% – after it had been stuck at 8.7% in April and May
• Chancellor Jeremy Hunt welcomed the drop but said the government knows high prices “are still a huge worry for families and businesses”
• Interest rates, mortgage repayments and house prices continue to worry many people. Analysts are predicting that, given the latest 7.9% figure, the Bank of England will add 0.25% to the current interest rate of 5% at the Bank’s next meeting in August
• The Liberal Democrats and Labour welcomed lower inflation but criticised the government, saying it should do more to help those struggling

Rob Morgan, Chief Investment Analyst at Charles Stanley, comments: “Falling inflation in the US and elsewhere had given hope that the UK’s sticky inflation might finally crack. Thankfully, there were indeed signs of more subdued price rises in June’s CPI print.

“In contrast to the two-year low for US CPI, which recently fell to 3%, the UK’s special brand of more stubborn inflation is proving trickier to tame. However, policymakers now have evidence they are on the right track. Headline CPI inflation fell more than expected from 8.7% in May to 7.9% in June, versus consensus estimates of a decline to 8.2%.

“It’s the first time inflation figures have come in lower than expected all year and gives the Bank of England (BoE) reason for cautious optimism.

“Meanwhile, the core reading, which strips out volatile energy and food prices, eased from 7.1% to 6.9% having surprised to the upside in June and hit its highest point since 1992.

“Fuel prices made the largest downward contribution to the CPI annual rate, and no doubt motorists have been thankful for easing prices at the pumps this year. Meanwhile, producer price inflation for goods is coming down nicely too. However, some areas remain sticky such as food and housing costs.”

“What does it mean for interest rates?

“Getting the inflation genie back into the bottle has proven troublesome for the Bank of England. The UK has the highest rate of the G7 economies, and the highest rate in western Europe, but there is now light at the end of the tunnel.

“Setting interest rate policy can be like an overly-sensitive shower dial. When the water is coming through too hot the dial needs to be turned to cool things down. However, turn it too far and you get an uncomfortable cold stream of water in the form of a recession. Today’s CPI print could mean the BoE chooses to ease off on the dial with a smaller 0.25% increase rather than a previously widely expected 0.5% one at the monetary policy committee’s next meeting on 3rd August.

“Longer term, the Bank of England (BoE) still has more work to do than other Central Banks. In the US, for instance, it may be that just one more rise is sufficient. However, markets are no longer convinced that UK rates will peak above 6%.

“What is the impact on households?

“Despite today’s more encouraging inflation data, irradicating inflation will still take some more time and persistence from the Bank of England. That means households and investors getting used to structurally higher interest rates than they have been used to for much of the past decade.

“While the Bank of England’s thirteen successive interest rate rises has already been unlucky for some, notably mortgagees whose favourable fixed rates have expired, the adverse environment is set to continue before it gets better. This will have progressively greater knock-on consequences for consumer spending as the months go by.

“The pressure on households has been unrelating when it comes to food and many other household costs, and although there are early signs of this easing food inflation is still outstripping the overall inflation rate.

“For savers, the increase in interest rates has been a welcome tonic compared with the dreary returns of much of the past decade. However, even the most competitive accounts pay significantly less than headline inflation meaning that the spending power of cash is stuck in reverse gear.

“What does it mean for investors?

“UK government bond markets have rallied over the past week, much of which has been driven by positive sentiment from a lower than expected CPI print in the US. Inflation will likely remain more persistent in the UK, and the BoE faces a very different challenge to the US Federal Reserve, but this latest inflation data will likely add some fuel to the government bond rally.

“The pound has been robust this year in the expectation that UK interest rates will peak and remain higher than in other countries in order to combat more persistent inflation. Today’s softer inflation reading has seen Sterling dip against other currencies. More widely, the pressure from inflation and interest rate worries could ease a little on UK assets with larger stocks with mostly overseas earnings under less pressure from the stronger pound.

“However, this is only one reading. Inflation numbers can be notoriously volatile and the UK is by no means out of the inflation woods.”

Ben Thompson, Deputy CEO, Mortgage Advice Bureau: “Although headline inflation has slowed more than expected, core inflation is still proving sticky and will remain on the minds of policymakers. 

“Lenders have held steady on rates over the past few days, adopting a ‘wait and see‘ approach. However, the core inflation reading is likely to signal the start of another choppy period, as lenders predict the Bank of England’s next move – a toss-up between a quarter or half point rise.

“The big question for mortgage holders is what they should do next, and with so much speculation on where we are on rates, it’s a hard one to answer. It’s important not to bury your head in the sand and to act early, so if you are within six months of your deal ending, now is the time to speak to your mortgage broker and see what your options are.”

 
Chris Daniels, Chief Commercial Officer of SmartSave, a Chetwood Financial company, said: “Today’s data confirms what we already knew – inflation is not falling fast enough, and the Bank of England may have to raise interest rates again. For savers, the question is whether they would see the direct benefits of the next interest rate increase, or whether they will continue to see their savings losing value in real terms.

“There is a huge gulf between the base rate and the rates available on many savings products. The larger banks, for example, are offering relatively low rates of between 0.9% and 1.75% on easy-access savings accounts. Fixed-rate products, particularly those not on the high street, are offering far higher returns. Those in a position to lock their savings away are likely to benefit from stronger returns and a better chance at protecting their money from the effects of inflation.

“Market conditions are turning in savers’ favour, but people would still be wise to hunt out the best deals based on the amount they can set aside and how long for. While challenger banks currently topping Best Buy tables may be lesser known, they are covered by the same Financial Services Compensation Scheme (FSCS) protection as the bigger banks, meaning that savers can securely open a new account within minutes online to secure competitive rates.”

 
Lily Megson, Policy Direct at My Pension Expert said: “Today’s figures have confirmed what many already assumed – inflation continues to plague Britons’ finances and will continue to do so for some time. And for those approaching or in retirement, it adds a further layer of uncertainty, as they consider how they can make their hard saved pension fight to hold its value.

“Remaining calm is vital. So, too is seeking the support from guidance, or use advice for personalised recommendations. From annuities to flexible access drawdowns, there are various options available to provide the right levels of security and risk which will suit individual needs – and under the current climate, the Government would be wise to point savers in the direction of both types of support to ensure they don’t inflict financial self-harm. After all, in the wake of its latest drive to improve pension outcomes, this could be a logical next step.”
 
Mohsin Rashid, CEO of ZIPZERO, said: “Some grocery staples have nearly tripled in price in the past two years, leaving millions of Britons at breaking point financially. Such increases have been simply unmanageable for consumers, so naturally any ease in inflation is welcome.

“But this small drop in inflation will not haul consumers back from the cliff’s edge. Yes, supermarkets have begun to react by cutting prices and introducing deals for loyalty card members, and the Government is trying to flex its muscles to encourage retailers to lower prices. But sadly, much of this feels a little like bolting the stable door with the horse well and truly out of sight.

“Action is needed. More price cuts, more rewards for loyal customers, and more scrutiny over profiteering from the cost of living. Meanwhile, with prices still so high, we should expect for consumers to continue turning to savvy measures to save cash, including shopping around for the best deals and utilising retailers’ loyalty and reward schemes to slash their monthly outgoings.”