UK inflation cools but core, services surprise to upside

British inflation slowed as expected in July to its lowest annual rate since February 2022, although there were more signs of pressure in core and services prices that the Bank of England is watching closely, data showed on Wednesday. The Office for National Statistics said annual consumer price inflation cooled to 6.8 per cent from June's 7.9 per cent, as the BoE and a Reuters poll of economists had predicted, moving further away from October's 41-year high of 11.1 per cent but still far above the central bank's 2 per cent target. Sterling rose slightly against the U.S. dollar on the back of the figures, which reinforced bets that the BoE will press on with its campaign of interest rate hikes.

The ONS said falling gas and electricity prices were the biggest driver behind the drop in inflation, while food price inflation also eased.

Despite the drop in the headline figure, Britain retains one of the highest rates of price growth in Western Europe, with only Iceland and Austria suffering higher inflation.

"With wage growth and services inflation both stronger than the Bank had expected, it seems clear that the Bank has more work to do," said Ruth Gregory, economist at consultancy Capital Economics. The BoE is watching core inflation - which strips out volatile food and energy prices - and consumer services prices closely.

Core inflation remained at 6.9 per cent in July, flat versus the June reading, and higher than expectations in the Reuters poll for a reading of 6.8 per cent. Services inflation picked up to 7.4 per cent from 7.2 per cent in June.

Financial markets on Wednesday showed a roughly two-thirds chance that the BoE's Bank Rate will hit 6 per cent in February, up from 5.25 per cent now. "While price rises are slowing, we’re not at the finish line. We must stick to our plan to halve inflation this year and get it back to the 2 per cent target as soon as possible," finance minister Jeremy Hunt said in response to the figures.

The data are likely to herald an imminent return to wage growth in real terms, which has been negative since April last year, adjusted for CPI. There were signs of a weakening of inflation pressure ahead from the manufacturing sector as factory gate prices fell by 0.8 per cent in the 12 months to July, the weakest reading since October 2020. Manufacturers' input prices fell by 3.3 per cent, the biggest fall since May 2020.