Sterling dips as inflation falls sharply to 2.6 per cent

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Rising prices have put pressure on consumers' ability to spend (Source: Getty)

Inflation slowed dramatically in June as fuel prices slumped, easing pressure on the Bank of England to raise interest rates at its next monetary policy meeting in August.

Consumer prices increased by only 2.6 per cent, the Office for National Statistics (ONS) said, with the consumer price index (CPI) and the index including housing costs (CPIH) both showing the same figure.

The fall was far bigger than economists had expected, pushing the value of sterling lower against the US dollar to $1.303 at the time of writing, undoing the gains of the past two sessions. The yield on the UK 10-year bond fell below 1.24 per cent, having this morning hit 1.31 per cent, as investors bought government debt.

A poll of consensus expectations had predicted consumer price index (CPI) inflation to remain steady at the 2.9 per cent rate seen in June. Inflation had previously risen steadily since March, and hadn't fallen since September last year, but declining oil prices stymied some of the rising price momentum.

Read more: Slowest UK economic growth since 2012 predicted as inflation hits consumers

Jonathan Athow, the ONS' deputy national statistician, said: “Today’s fall in inflation is mainly due to drops in petrol and diesel prices. However, the rate remains higher than in the recent past."

In January Brent crude oil prices peaked above $60 per barrel and have since declined to below $50 per barrel as oil cartel Opec (the Organisation of the Petroleum Exporting Countries) struggled to sustain the prices through production freezes. The prices of some recreational and cultural goods and services, including data processing equipment and toys, also contributed towards the fall.

Tipping the MPC balance

The fall in headline inflation will likely tilt the Bank of England's monetary policy committee (MPC) away from a vote for an interest rate hike, after a flurry of interviews by policymakers in recent weeks had put tighter monetary policy on the table.

However, the balance of the committee already appeared to favour holding policy, in line with the views of Bank governor Mark Carney, despite forecasts suggesting inflation will rise above three per cent this year.

Howard Archer, chief economic advisor at EY Item Club, said: "The unexpected drop in inflation in June markedly dilutes pressure on the Bank of England to raise interest rates at the early-August MPC meeting – especially given stuttering UK economic activity and current ongoing muted earnings growth."

Economists will now model how far the fall in inflation is a temporary or a permanent phenomenon. Headline inflation could well bounce back, warned Andrew Sentance, a former MPC member and now PwC senior economic adviser.

"We have not necessarily passed the peak of inflation," he said.

"Oil prices are volatile and could bounce back later this year. Meanwhile, the big fall in the value of the pound since last summer is still working its way through the pipeline and has not yet fully fed through into shop prices."

Devalued sterling

The surge in consumer prices in the last year has been driven by the devaluation of sterling, which has fallen around 13 per cent against the dollar since the Brexit vote last June. The latest figures suggested that influence may finally be waning, with producer price inflation easing to 9.9 per cent. Core inflation also moderated to 2.4 per cent.

In June 2016 consumer price inflation was running at only 0.5 per cent, but the weaker pound has made imported products relatively more expensive. This has gradually fed through into higher prices in the shops for UK consumers.

The rise in inflation and the consequent squeeze on discretionary incomes have in turn raised fears over the consumer spending which drove resilient GDP growth in the immediate aftermath of the Brexit vote. Inflation is still likely to have far outpaced wages over the past year, which rose by only 1.8 per cent in the year to May.

Growth slowed to 0.2 per cent in the first quarter of 2017, with second-quarter data due to be published next Wednesday.

Read more: Consumer confidence has fallen for the third quarter running

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