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Pound falls as steady inflation eases rate rise pressure

Inflation holds steady at 2.6% in July, further easing any pressure on Bank of England to raise interest rates, say economists.

Pound falls as steady inflation eases rate rise pressure

The pound has fallen against the dollar on new inflation held steady at 2.6% in July, further easing any pressure on the Bank of England to raise interest rates.

Figures from the Office for National Statistics (ONS) showed inflation, measured by the consumer prices index (CPI), at 2.6% in July, a weaker than expected reading resulting from lower energy prices and supermarkets absorbing higher food costs. Investors had been anticipated inflation to bounce back after June's surprise fall.

The news pushed the pound 0.9% lower against the dollar at $1.285, with the greenback also buoyed by strong US retail sales and manufacturing figures. Against the euro, the pound dropped 0.3% to €1.097.

The retail price index (RPI), which unlike CPI includes housing costs, increased 3.6% in July, up from 3.5% in June.

James Smith, developed markets economist at ING, said he expected inflation to inch closer to 3% towards the end of the year, as the 20% fall in sterling since November 2015 filters through to the numbers.

This echoes the Bank’s latest inflation report, which forecasted that inflation would peak at 3% in the autumn.

Smith said the latest inflation data would continue to test the patience of Bank of England hawks.

'We expect the committee as a whole to continue looking through inflation spikes in favour of slower growth. We don’t expect a rate hike this year,’ he said.

Brexit uncertainty

Thomas Wells, manager of Smith & Williamson’s Global Inflation Linked Bond fund, said headline inflationary pressures would only begin to moderate next year 'as the large year-on-year slump in sterling drops out of the numbers'.

‘CPI remains well above the Bank of England’s 2% target and we expect it to remain elevated throughout the third and fourth quarters,’ he said.

Wells agreed the Bank was unlikely to raise interest rates because of the uncertainty surrounding Brexit and low savings levels. He added that the Bank would be reluctant to 'throw the consumer out of bed' at a time when wage growth was failing to keep pace with inflation.

However, headline inflation figures are not the only factor that influences the monetary policy committee's interest rate decision. They will also look closely at the impact inflation is having on consumers.

At present wage growth is just 2%, according to ONS figures, which means the cost of goods and services is rising more quickly than pay.

Smith believes this will be a consideration for the Bank. He expects wage growth to remain at 2% for the rest of the year.

‘The combination of slowing economic momentum, political uncertainty and rising import costs mean that firms are likely to have limited incentive to accelerate pay rises,’ he said.

Rail fares to rise

Wells anticipates that consumers may have to live with price rises beyond 2017. He gave the example of regulated rail fare rises, which will jump in January based on July's 3.6% RPI reading.

‘Even if the government intervenes for political reasons and limits the increase to, say 3%, a £5,000 season ticket will still cost an extra £150 a year in January,’ said Wells.

‘Some unregulated fares are likely to go up much more. Utility tariffs and other bills are also linked to inflation, so consumers can expect to be hit in the pocket there too.’

Chris Williamson, chief business economist at IHS Markit, said real earnings were 'likely to continue falling for some time, as inflation exceeds pay growth’.

‘While inflation is expected to edge up further in coming months, there’s little sign of pay growth accelerating meaningfully.'

The economist said households were feeling the pinch more than at any time over the past three years. Likewise, household finances are deteriorating as a result of rising debt and falling earnings. This means that higher prices pile 'additional pressure on to already-squeezed budgets’.

‘The lower than expected inflation rate adds to the belief that the majority of policymakers at the Bank will be more worried about economic growth than inflation in coming months,’ said Williamson.

‘Risks remain biased towards the economy slowing further after a weak first half of 2017, with consumer spending dampened at the same time as business spending is hit by rising anxiety about Brexit.’

1 comment so far. Why not have your say?

Alan Tonks

Aug 15, 2017 at 18:59

“Smith said the latest inflation data would continue to test the patience of Bank of England hawks.”

What a load of twaddle, hawks you must be joking more like flea bitten vultures!!

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