U.K. Inflation Looks To Have Finally Broken

Inflation came in well below market and BoE expectations, with declines both in core goods and services. Before anyone gets too excited about risk, however, we think this augers slower GDP growth through the end of the year, as also reflected by the country’s higher unemployment rates seen in July.

U.K. core CPI was 6.2% year-over-year in August versus the expected 6.8%, with the shortfall driven by deceleration in most goods and services. Core goods fell from 5.9% to 5.2% – their lowest since December 2021 – while services eased from 7.4% to 6.8%.

Despite its decline, services inflation is still being affected by travel and transportation (8.9% in August from 10.6% in July), as well as recreation and personal services (7.8% from 8.9%).

Within the recreation and personal sector, package holidays and accommodation rose 8.8% in August, their slowest reading since May 2022.

Given that U.K. employment has been softening, with the unemployment rate up at 4.3% in July from a low of 3.5% in August 2022, there should be scope for further deceleration in services inflation.

The services component of GDP declined 0.50% month-over-month (MoM) in July and real retail sales ex-auto fuel were just 0.6% MoM in August after falling by 1.4% the previous month.

With this new data, we may see lower U.K. interest rate volatility and greater confidence in U.K. fixed-income markets. While this is a welcome development, however, it’s too soon to start thinking about rate cuts, despite likely slower growth and worse employment figures.

The U.K. still has some of the highest inflation rates in the world, both on a headline and core basis, and they are going to take more time to decelerate.

Given that we assume inflation will be stable to lower from here, this pause from the BoE may be permanent, suggesting that we have likely seen the country’s peak policy rates for the current cycle.