Food prices rose 4.4%, the highest since February 2024. Retailers blamed the recent increases in payroll taxes and the minimum wage — changes that came into effect in April.
Matthew Ryan, head of market strategy at global financial services firm Ebury, laid the blame in part “on labor cost pressures emanating from April’s hike to the minimum wage and business tax rates, which are forcing employers to raise prices to cover the increase in cost.”While traders still expect the BOE to press ahead with an interest-rate cut on Aug. 7, they pared back expectations for future reductions as the release created a new headache for officials.
The Labour government is banking on a pick-up in the economy to help fund its spending ambitions after parliamentary rebels forced it to shelve a series of spending cuts.
However, there is mounting evidence that its first round of tax hikes — revealed in last autumn’s budget — has taken a toll on the economy, causing firms to rein in hiring and push up prices. Speculation is rising over more tax increases in the coming autumn despite the head of the UK’s fiscal watchdog warning of a hit to growth given the near-record-high tax burden.
Chancellor of the Exchequer Rachel Reeves acknowledged that working people are “still struggling with the cost of living” following Wednesday’s figures.
Services inflation — a sign of domestic pressures being watched closely by the BOE — held at 4.7%, higher than expected. Ruth Gregory, deputy chief economist at Capital Economics, said higher-than-expected hotel inflation and climbing clothing and footwear costs “may be a sign” that firms are passing on employment costs.
Food PricesGrocery bills are also becoming a concern given their salience for household inflation expectations, with the retail sector one of the hardest hit by the budget changes. Prices for beef and veal, butter and chocolate rose sharply year-on-year.
“Despite fierce competition between retailers, the ongoing impact of the last budget and poor harvests caused by the extreme weather have resulted in prices for consumers rising,” said Kris Hamer, director of insight at the British Retail Consortium.
The ONS also said inflation was “driven mainly by motor fuel prices which fell only slightly, compared with a much larger decrease at this time last year.”
The pound rose 0.1% to $1.34, set to snap a eight day losing run, and bond prices dipped, pushing up the yield on 10-year gilts by 4 basis points to 4.66%. Traders pared bets on BOE interest rate cuts, and now see 49 basis points of easing by year-end, compared with 53 basis points ahead of the data.
The figures are also a headache for BOE Governor Andrew Bailey, who has signaled that more rate cuts are ahead after sharp falls in employment since the budget changes. The UK central bank had predicted in May that CPI would remain at 3.4% throughout the summer before accelerating again in September.
While overall inflation is well above the central bank’s 2% target, the BOE has predicted the pick-up will start reversing by the end of the year and is putting more focus on underlying indicators. That’s in part because a recent cooling in the economy — including a weakening in the labor market — is likely to slow the pace of consumer-price increases.
Despite the increased pressures in the short run, the tax increases’ dampening effect on the jobs market is likely to weigh on wage and price growth in the medium term — the horizon the BOE targets inflation.
“With inflation still proving sticky and economic growth stagnating, the UK is skirting the edges of stagflation,” said Anna Leach, chief economist at the Institute of Directors.
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