Why has inflation fallen and what does it mean for you?

Consumer price index inflation has fallen more than expected thanks to a fall in transportation and food prices, but most costs continue to rise.

The CPI fell to 7.9 percent in June, a figure below forecasts of 8.2 percent, the Office for National Statistics announced today.

This was the lowest CPI rate since March last year, when inflationary pressures began to reinforce the overall figure.

Despite the bigger-than-expected drop, experts warn that inflation numbers will do little to change the outlook for the UK economy, with interest rates still set to rise and prices remaining stubbornly high.

We explain why inflation has fallen and what that means for you.

What happened to inflation?

CPI inflation fell further than expected to 7.9 percent in June from 8.7 percent in May, the ONS said today. But this remains well above the Bank of England Monetary Policy Committee’s target of 2 per cent.

Victoria Scholar, head of investment at Interactive Investor, said: ‘While this is a step in the right direction, it still looks like Prime Minister Rishi Sunak’s goal of halving inflation this year will be difficult to achieve.

And the Bank of England is still expected to keep raising rates to bring price pressures back to the 2% target.

“Inflation in the UK is still very high by international and recent historical standards, with food prices growing sharply faster than the CPI, adding to the pressure for many households and businesses.”

CPI measures the average month-to-month change in the prices of consumer goods and services purchased in Britain, with the ONS monitoring a basket of goods representative of UK consumers.

The rate peaked at 11.1 percent in October and turned out to be “stickier” than expected, with the falling rate still well above peers in other developed countries.

Why did inflation fall more than expected?

The biggest driver of last month’s drop was transportation costs, which fell 1.7 percent in the year to June after a 1.3 percent fall in rice in May thanks to motor fuel prices falling 22.7 percent after another drop of 13.1 percent.

Consumers will also welcome tentative signs that food inflation has already peaked, having hit an eye-watering 45-year high of 19.2 percent in March.

Prices for food and non-alcoholic beverages are up 17.4 percent in the year to June, up from 18.4 percent in May.

The main contributors to this decline were milk, cheese and eggs, three foods that have seen some of the most dramatic price increases in the past two years.

Where does inflation still have the greatest impact?

Despite falling 27.4 percent in May, milk, cheese and egg inflation of 22.8 percent year-to-June will undoubtedly continue to pressure consumers.

And while the ONS said “there were no major offsetting upward contributions to the change” in the CPI rate, many other goods and services are still experiencing high levels of inflation.

For example, inflation in restaurants and hotels was 9.5 percent in June, while prices for alcohol and tobacco are rising by 9.2 percent annually and those for clothing and footwear by 7.2 percent.

What happens besides inflation?

Prime Minister Rishi Sunak promised to halve inflation this year and bring it back to just over 5 percent by the end of 2023.

When he made that promise in January, it seemed that the math was in his favor and inflation would fall that much.

However, inflation has proved more stubborn than thought, and the prime minister is on shaky ground. The good news is that core inflation — the underlying rate that excludes volatile energy and food prices and tax-heavy alcohol and tobacco — has fallen to 6.9 percent.

Thomas Pugh, economist at RSM UK, said: ‘We think inflation will continue to fall from now on as lower energy and commodity prices continue to feed through.

In fact, factory output prices rose just 0.1 percent y/y in June – a good sign for future commodity price inflation.

In addition, as labor supply improves and labor demand eases somewhat, increasing slack in the labor market should reduce wage growth in the coming year, limiting the risk of a wage-price spiral.

What does the drop in inflation mean for interest rates?

Financial markets cheered the latest data from the ONS, with the FTSE 100 and FTSE 250 rising sharply, the pound falling and government bonds trading higher, reflecting market expectations that the Bank of England’s key interest rate could not rise as high as previously was feared.

That doesn’t mean there won’t be more base rate hikes, though, just that there may not be that far left before the peak.

Some experts warn that the BoE is still facing stubbornly high inflationary pressures by global standards, particularly in terms of wage inflation, meaning it is unlikely to derail on its rate gains.

Markets are currently still predicting a base interest rate peak of 6 percent in December, where it is expected to last for much of 2024.

This will inevitably put further pressure on borrowers and mortgage holders, especially those who need to take out a new mortgage in the next 18 months.

Pugh believes the rate is unlikely to rise above 6 percent, but said further increases are likely.

He said: ‘Inflation is proving more persistent in the UK than elsewhere. Greater labor market tightness than in the EU and the US, coupled with a slower fall in energy costs, means the Bank of England still has a lot of work to do before it can ease.”

Hussain Mehdi, macro investment strategist at HSBC Asset Management, added: “This is preliminary evidence that UK inflationary pressures are finally turning.

Nevertheless, with economic activity generally remaining resilient – ​​and, crucially, the labor market still too hot – the Bank of England will remain under significant pressure to implement further policy tightening. We wouldn’t shy away from market prices of a 6% terminal bank rate and think interest rate cuts are unlikely until late 2024.

In this ‘higher-for-longer’ interest rate environment, GDP growth is likely to weaken significantly as the lagged effect of rate hikes feeds through to activity.

‘Higher mortgage payments weigh on the housing market and consumer spending. As a result, we remain cautious on asset classes in the UK.”

Is falling inflation good news for mortgages?

Sarah Coles, head of personal finance at Hargreaves Lansdown, agreed that the BoE’s growth cycle is unlikely to be slowed by slowing inflation, but she said the latest CPI figure is good news for mortgage lenders.

Coles said: “Due to declining inflation, the Bank may not be so tempted to lean on this leverage in the coming months, and that in itself is enough to get the markets moving.

“Savers and mortgage borrowers do not have to wait for the next interest rate decision for this to take effect, because a change in expectations would be significant in itself.”

She added that variable mortgages will change “little” in the short term, but future increases in base rates will inevitably increase payments.

Coles said, “However, for those coming to the end of a fixed rate deal and looking to take out a new mortgage, a fall in interest rate expectations can make a huge difference.

“The market has priced in an awful lot of rate hikes, pushing the average two-year fixed rate to an appalling 6.78 percent, according to Moneyfacts.

But if inflation continues to fall, there may not be as many increases needed. If the market is convinced of this, we could drop the fixed mortgage rate a little – well before the MPC meets again.’