UK inflation slows to 2% in July but ‘don’t get too comfortable’, analysts say

Prices expected to rise sharply in the coming months, hitting 4% by the end of the year

Clothing discounts started later in the summer this year, helping to drive down inflation in July. EPA

UK inflation slowed to 2 per cent in July in what analysts consider a temporary blip with the rate expected to double by the end of the year.

The Consumer Price Index fell from 2.5 per cent in the year to June, the highest rate in almost three years, to the Bank of England’s inflation target of 2 per cent, with the dip driven by price falls in clothing and footwear that largely offset increases in transport costs.

The slowdown also partly reflects a sharp rise in prices in July last year, when some of the restrictions imposed during the first Covid-19 lockdown were eased.

“Inflation fell back in July across a broad range of goods and services, including clothing, which decreased with summer sales returning after the pandemic hit the sector last year,” said Jonathan Athow, deputy national statistician at the Office for National Statistics.

"This was offset by a sharp rise in the price of second-hand cars amidst increased demand, following a shortage of new models.”

While inflation decelerated in July, analysts warned consumers that this does not mean they are in for an easy ride post pandemic.

Instead, inflation is expected to rise again, in line with the Bank of England’s expectation at its last Monetary Policy Meeting this month that it would jump to about 4 per cent by the end of the year, which would be a decade high. But the Bank of England stuck to its view that the acceleration of inflation would be temporary.

Sarah Cole, personal finance analyst at Hargreaves Lansdown, urged consumers not to get "too comfortable" as inflation was held back by an artificial bump in prices a year ago when the ONS stopped using estimates and stared measuring prices again.

"When this drops out of the figures, inflation will rise,” Ms Cole said. “The underlying pressure on prices, particularly from soaring petrol and second-hand car prices, mean it’s set to pick up speed again soon, and may well hit 4 per cent by the end of the year.”

A shift in seasonal fashion sales also fed into the depressed figures for July, Ms Coles said, with summer sales starting later than usual "because lockdown depressed prices in the first two months of the year and retailers have been making up for lost time ever since”.

Computer games also pushed prices down, along with a variety of recreational goods and services. However, fuel prices reached the highest level in eight years at £1.33 ($1.82) per litre, pushing up inflation, while second-hand car inflation hit 14.4 per cent in July, up from 5.6 per cent in June, providing further evidence that the semi-conductor shortage that has hampered new car production is boosting demand for used cars.

Meanwhile, manufacturers felt stronger-than-expected inflation in the cost of raw materials and for goods leaving factory gates. Input prices rose 9.9 per cent on prices a year ago, more than the 9.7 per cent pace of the previous month, while output costs rose 4.9 per cent, the highest since December 2011.

“The differing patterns of movement restrictions across the last two years have affected headline inflation,” Mr Athow said. “Some of this month’s fall came from products and services, such as foreign travel, where real prices were used last year but have had to be imputed this year.”

While Ruth Gregory, senior UK economist at Capital Economics, expects inflation to a peak at about 4.5 per cent by the end of this year, she does not expect the BoE to shift its policy stance.

“Provided higher inflation does not feed through into higher inflation expectations or persistently faster pay growth, we do not think that the BoE will respond next year by tightening monetary policy,” she said.

While the months ahead will not be comfortable for the Monetary Policy Committee, Ms Gregory expects inflation to fall back to 1.5 per cent by the end of 2022 “meaning that the MPC will look through the upcoming spike in inflation and keep interest rates at their current levels until mid-2023”.

However, with inflation prediction not an exact science, Ms Cole said there are some signs of more enduring inflationary pressures.

“The cost of raw materials is rising for manufacturers, and while many of them are keeping a lid on the price of the finished products, if they come under too much pressure, they’ll pass them on to consumers.,” she said.

“They also face the threat of possible wage rises as vacancies hit record highs. If we get prices and wages both rising together, we could find ourselves in an inflationary spiral that’s very hard to get out of.”

On the other hand, the UK economic recovery is still at risk of being derailed by Covid-19 again.

“How the spread of the Delta variant changes when we move inside during the autumn and winter is an unknown quantity, while new variants could cause a whole new set of problems," Ms Cole said. "If this happens, inflation could be a distant memory in a matter of weeks.”

Separately, house prices rose 13.2 per cent in June, according to the ONS, taking the average house price to £266,000 – £31,000 higher than the same month a year ago – as buyers rushed to complete purchases ahead of the stamp duty holiday deadline on June 30, which offered a saving of up to £15,000 on the first £500,000 of the purchase price.

"In June, UK house prices recorded their highest annual growth since 2004," said Mike Hardie, head of prices at the ONS.

"This figure, however, was boosted by large monthly growth, with a rush to complete purchases before changes to the stamp duty holiday came into effect at the end of June."

While the Halifax house price index showed that UK house price growth cooled in July, as the tax break tapered off, agents are now expecting momentum to return to the market as overseas buyers, particularly from the Arabian Gulf and wider Middle East region, flock to London to snap up properties after travel restrictions were eased.