UK Reaction: Energy pushes headline lower, but strength in services sees core remain elevated

• CPI inflation eased to 6.8% year-on-year (y/y) in July, driven primarily by falling energy prices. This came in line with Refinitiv consensus expectations and Bank of England (BoE) forecasts.
• Core CPI remained at 6.9% - above consensus estimates of an easing to 6.8%. Strength in core driven by pick up in core services offsetting falls seen in core goods. Services CPI rose to 7.4% from 7.2% prior driven by increases in airfare prices.
• We continue to expect the BoE to hike by 25 basis points (bps) at its next meeting in September, bringing Bank Rate to 5.5%, which we think will prove a peak. Upcoming inflation and labour market releases remain important.  

CPI inflation eased to 6.8% y/y in July from 7.9% in June. This came in line with Refinitiv consensus estimates and the BoE's forecast published earlier this month. Core CPI inflation remained at 6.9% a touch above consensus expectations of core falling to 6.8%. Retail Price Index (RPI) inflation fell to 9% (in line with expectations) whilst Retail Price Index excluding mortgage interest payments (RPIX) fell to 7.9%.

The slowdown in prices was driven by falling electricity and gas prices as the Office of Gas and Electricity Markets price cap was lowered to £2,074 in July, falling below the Government's Energy Price Guarantee cap of £2,500 prior. The fall in household energy costs contributed 0.8 percentage points (ppt) out of the total 1.1ppt fall. The downward contribution of energy to inflation has turned negative, but has further to go; we expect energy costs to fall again in October lowering headline inflation by around 1.6ppt. Petrol prices rising slower than last year also contributed to the decline (-0.1ppt). 

The pace of price increase in food decelerated considerably adding to the disinflation (0.3ppts out of total 1.1ppt fall). Food prices rose by 0.1% between July and June, compared to a staggering monthly increase of 2.2% last year. Annual food inflation now stands at 14.8% down from a peak of 19.1% in March 2023. The easing was broad based with 10 out of 11 food classes seeing a fall in the annual inflation rate, with some staples such milk, eggs and cheese seeing prices fall on the month. Clearly food inflation remains uncomfortably high, but when taken alongside evidence of a continued easing in input prices and price cuts of staples in stores, we expect food prices to continue to moderate over the coming months. 

Falls in communication prices also contributed to the decline (-0.1ppt) as prices eased 2.5% on the month. Transport prices also picked up more than usual in July. Increases in the price of transport services contributed positively to inflation (0.1ppt) with airfares driving this increase, rising by 25.3% on the month.

Core and services CPI, which have risen in recent months fuelling fears of inflation persistence, remain elevated. Core inflation remained at 6.9% and services inflation rose further to 7.4%, with the pick-up in services inflation equalling May as the highest reading seen since March 1992. The momentum in core inflation has cooled considerably with the one month annualised core CPI at 3.8% and todays Producer Price Inflation release also showed core producer output prices fell further to 2.3% this month. We expect core inflation to continue to ease, but expect core goods to do much of the heavy lifting. For services there is more uncertainty and we expect this measure to be slower to decline; the pickup seen in this month's data was driven in part by airfares which tends to be volatile and much of the pickup will unwind after school holidays in September, but the strength of yesterday's wage data points to pressure on services prices which is likely to endure. 

The BoE's Monetary Policy Committee (MPC) next meets on 21 September, when we expect it to deliver a 25bps hike bringing Bank Rate to 5.5%. Before the September meeting we will also receive another round of inflation and labour market data which will remain important. The BoE has indicated that the current level of Bank Rate is restrictive, and their preference to hold rates at its peak for longer, rather than taking rate further into restrictive territory and cutting rates earlier, but this can only occur if the data allows them to pause. By the time November comes around we expect to see further signs of slowing in the labour market and an easing of price pressures we think which will allow the MPC to pause its hiking cycle. We think the BoE will begin cutting rates in the second half of 2024, pencilling 50bps of cuts in total, bringing Bank Rate to 5% by end-2024.