UK inflation fell further than expected in June to 7.9% amid a sharp drop in petrol prices, easing forecasts for how aggressively the Bank of England will raise interest rates over the coming year.
In the first positive surprise for inflation since January, the Office for National Statistics said the annual inflation rate as measured by the consumer prices index resumed a downward path after unexpectedly sticking at 8.7% in May. The drop exceeded City forecasts for a decline to 8.2%.
Financial markets responded by betting that the Bank of England would no longer drive interest rates above 6% early next year, raising hopes for some modest relief for mortgage holders amid the sharpest rise in borrowing costs for decades.
The pound fell by more than a cent against the dollar to trade below $1.29. Shares on the London stock market rallied as investors predicted that the central bank would introduce a more modest quarter-point rise in borrowing costs at its next policymaking meeting in August instead of a tougher half-point increase from the current level of 5%.
However, despite dropping to the lowest rate since March 2022, UK inflation remains the highest among the G7 group of advanced economies.
Highlighting the risk that Rishi Sunak could still miss his target to halve inflation in 2023 despite the improvement in June, the International Monetary Fund said the UK’s headline rate was on track to hit 5.25% by the end of 2023.
The Washington-based fund said there was a “high” risk of inflation sticking at elevated levels, forcing the Bank to keep interest rates higher for longer and raising the chances of a recession.
Inflation stood at 10.7% when Sunak promised to halve it, at a time when most economists thought it would happen anyway. Speaking on a visit to the headquarters of Jaguar Land Rover in Gaydon, Warwickshire, the prime minister said he “always knew” his targets would be difficult to meet.
“I don’t make any apology for that. I think it’s right to be ambitious for the country and set ambitious targets that I want to achieve,” he said.
According to the latest snapshot from the ONS, the fall in the inflation rate in June was driven by the price of petrol and diesel dropping by more than a fifth compared with the same month a year ago, when prices were close to a record high.
The annual rate of increase in food and drink prices slowed in June to 17.3%, compared with 18.3% in May, helping to bring down the headline inflation rate.
Core inflation, which strips out food and energy, and is closely watched by the Bank of England, also fell back to 6.9% after reaching a 30-year high of 7.1% in May.
Prices for some goods continued to rise sharply – including a 54% jump in the price of sugar after bad weather hit harvests around the world. While increases in the price of milk, cheese and eggs eased, they were still up by more than a quarter compared with a year ago.
Inflation is on course to drop further in the coming months after Ofgem lowered its consumer energy price cap in July, reflecting a fall in wholesale gas and electricity prices. Liquid fuels, which were not subject to a cap, fell by almost 50%.
Highlighting the potential for further declines, producer price inflation – which measures factory gate prices – fell close to zero, from a peak of about 25% last year.
“The main story today is that inflation is lower than expected, fuelling a narrative that we are through the worst,” said Kitty Ussher, the chief economist at the Institute of Directors. “The Bank of England will hope that this will cause business leaders and others to lower their expectations of future inflation, which could then become self-fulfilling.”
The Bank has already raised interest rates 13 times in succession to 5%, up from a record low of 0.1% in December 2021, adding to the pressure on businesses and households amid the cost of living crisis.
The chancellor, Jeremy Hunt, said the best way to ease the pressure on households was to get inflation falling further. “We aren’t complacent and know that high prices are still a huge worry for families and businesses,” he said.
Charities warned that the cost of living crisis was still far from over, with prices remaining significantly higher than they were two years ago, and continuing to rise at historically high rates.
Alfie Stirling, the chief economist at the Joseph Rowntree Foundation, said: “We must recognise we are still in the belly of this crisis. For the 5.7 million low-income families in this country already forced to eat less or skip meals, inflation at close to 8% and food inflation above 17% will come as precious little comfort overall.”
UK inflation remains higher than in many comparable economies.
Inflation in the eurozone fell to 5.5% in June, with the rate below 2% in Spain. US inflation cooled to 3%, easing pressure on the US Federal Reserve to increase interest rates much further.
“Inflation has been persistently high and remains higher than our international peers. This is becoming a hallmark of Tory economic failure,” said Rachel Reeves, the shadow chancellor.
