IInflation is up… and that’s, um, good news. No, really. Listen to me.
In fact, this is relatively good for interest rates, for borrowers and for the economy as a whole, and for very good reasons. First, the increase in the annual rate for July (the price change since July 2023) of 2.2 percent is actually somewhat lower than markets expected.
This is not a purely psychological issue, such as the relief that comes when energy bills stop rising as much as they did before (although they do); it is also a matter of reality, in the sense that market expectations actually matter.
Both the Bank of England and investors will look at these numbers – and the underlying trends – and conclude that inflation is still moderating from the extremely high rates (double digits) seen in 2022. This is good news. A small cut in the base rate from the current 5 percent to, say, 4.75 percent in September, October or November is a little more likely today than it seemed yesterday.
Of course, everything is relative. Energy prices have not returned to their previous levels since the war in Ukraine pushed up wholesale prices for gas and oil. Nevertheless, have Prices have been falling throughout 2023 and this year, so a price index reflects the fact that they are falling (although not as fast). They are also far from back to “normal” – and may never be as long as sanctions against Russia remain.
Some costs have even gone down – like eating out or staying in hotels. Bills for these types of activities have gone down this year after rising last year.
More importantly, underlying or “core” inflation is trending better. The key statistic for this is the so-called “core CPI”: a consumer price index that excludes more volatile costs such as housing, energy, food, alcohol and tobacco. By this definition, prices rose by a total of 3.3 percent in the year to July 2024 – down from 3.5 percent in June 2024 and below the recent peak of 7.1 percent in May 2023, the highest increase since 7.2 percent in March 1992.
The core inflation trend confirms what we saw in the wage data released yesterday: prices/costs continue to rise, but the rate has moderated over the past 18 months or so.
That said, the Bank of England can take comfort in the fact that its key interest rate hikes (which it began in December 2021) have had the desired effect, exerting steady but gentle pressure.
Generally, it takes about one to two years for the impact of interest rate changes to be felt in the economy, as people refinance their mortgages and companies roll over their debts and the downward pressure on demand and prices is fully felt. So the bank expects pressure to start in 2025 – and the successes so far give cause for some encouragement.
Yet “domestic” inflation – the dreaded wage-price-wage spiral – is still too high for comfort and is proving very stubborn in some respects, with Britain facing labour and skilled labour shortages post-Brexit and the pandemic, becoming intractable at a time when immigration (though high) is so unpopular.
So we can expect the Bank to remain cautious and the Monetary Policy Committee’s decisions to continue to be unusually tight and balanced. They will also feel more confident because Rachel Reeves is running a fairly tight fiscal policy that supports the Bank’s efforts.
Overall, the UK is on a very narrow path to modest economic growth, but is constantly threatened and constrained by the threat of accelerating price inflation, so one should not expect too dramatic changes in interest rates (in either direction) in the coming months.
