Despite an unexpected rise in inflation, investors remain confident that the Bank of England (BoE) will move ahead with a reduction in interest rates next month. In June, inflation reached its highest level in nearly 18 months, fuelled by increasing food and fuel prices. Nevertheless, expectations remain strong for a rate cut at the next policy meeting on 7 August.
Although inflation continues to sit above the Bank’s 2% target, many economists believe the central bank will proceed with another cut. Since August last year, when the Bank first lowered rates from 5.25%, it has taken a cautious approach, implementing reductions every three months. The current base rate now stands at 4.25%.
Figures from the Office for National Statistics (ONS) showed that consumer prices increased by 3.6% in June, up from 3.4% in May. This marks the fastest annual rate since January 2024. The ONS attributed the rise primarily to higher food costs, with fuel and transport also playing a role in pushing prices up.
Despite the inflation increase, financial markets still see a strong chance of a rate cut. The probability of a reduction in August now stands at 87%, slightly down from 89% earlier in the week, but still a clear majority.
Economists remain divided on the implications of these figures. Suren Thiru, economics director at ICAEW, commented that June may signal the beginning of a modest summer increase in inflation, driven by rising business expenses and global supply issues. However, he noted that despite this, the BoE is still likely to push ahead with its planned August cut due to wider economic concerns.
A key measure followed closely by the Bank of England—services inflation—remained unchanged at 4.7% in June. This measure is considered a more accurate reflection of domestic inflationary pressures than the headline rate.
Deutsche Bank’s chief UK economist, Sanjay Sanjay, dismissed the idea that the rate cut is under threat, saying that the broader economic picture, including slowing GDP and a softening jobs market, still supports a careful and measured easing of monetary policy. He added that much now depends on labour market performance in determining how quickly and how far interest rates may fall.
The Monetary Policy Committee (MPC) last voted six to three in favour of holding the rate steady at 4.25%, following a previous quarter-point cut in May. In total, the committee has lowered interest rates four times since summer 2024.
Chris Beauchamp, chief market analyst at IG, pointed out that while inflation is putting additional pressure on consumers, the underlying trend in core goods and services remains relatively stable. He noted that the focus will now shift to the upcoming labour market data for further clues on the Bank’s next steps.
Markets are currently pricing in at least one more rate cut by the end of the year. However, opinions remain mixed on whether the Bank will be able to justify further reductions in the face of renewed inflationary pressures.
Isaac Stell, investment manager at Wealth Club, remarked that the surprising jump in inflation complicates an already challenging economic landscape. He warned that if the BoE refrains from cutting rates, households may continue to experience financial strain—posing a challenge to the government’s plans for economic growth. Referring to recent sluggish economic performance, Stell said, “Awful April has rolled into miserable May and in turn rolled into joyless June,” adding that the government would now be hoping for a more positive shift in July.
Not all experts are on board with the idea of rate cuts. Former MPC member Andrew Sentance argued that reducing interest rates after the recent inflation spike would be “irresponsible”.
However, Bank of England Governor Andrew Bailey indicated in a recent interview that future rate cuts are still on the table. He stated that if the labour market shows further signs of cooling, then “the path is downward” for interest rates.
Key updates on the UK labour market are due this Thursday at 7am, and the Bank of England is expected to announce its next rate decision on 7 August around midday.
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