Bank to hold rates as inflation falls

Interest rates could stay at record lows as a result of the dip in inflation last month, which is expected to push Bank of England policymakers to reconsider voting for a rate rise. Price rises fell back to 2.6 per cent in June, down from 2.9 per cent in the 12 months to May.

What are we to make of the figures out yesterday that showed there was a lower-thanexpected rate of inflation in June?

The key question appears to be whether price rises have really calmed down or whether they are merely pausing for breath before rising again later in the summer.

Inflation rose above the Bank of England’s target rate of 2pc in February, overtook wage growth in March and hit 2.9pc in May – just a shade below the 3pc level at which Mark Carney, the Bank’s Governor, has to write a letter to the Chancellor of the Exchequer explaining why things are going awry.

Most economists expected it to stay at around 2.9pc in June; instead figures out yesterday showed that it had dropped to 2.6pc.

This has dampened speculation that the Bank will raise interest rates in August, and the pound fell accordingly.

CPI figures are quite volatile. Price rises may have peaked. But it is just as possible that it was the high May figure that was the anomaly and that last month’s figure actually fits into the forecast rise in inflation leading to a peak later in the year.

Most of the recent increase in inflation was caused by two big one-off events.

The first was the sharp fall in the value of the pound after the UK’S referendum on membership of the European Union in June last year.

The second was the rise of energy prices following sharp falls in the price of oil in early 2016.

The two factors fed off each other because oil is priced in dollars, and so the rise in the value of crude was exacerbated by the fall in sterling.

For all the talk of shoppers being hit by higher prices, it was actually transport costs that were the biggest single contributor to rising inflation at the beginning of the year.

That being the case, the Bank arguably never needed to raise interest rates to head off inflation, rather it just had to sit on its hands and wait.

The main reason for the lower-thanexpected rate of inflation last month was lower prices for petrol and diesel.

Barring some geopolitical flare-up that leads to a bump in oil prices, this downward pressure will only increase.

Prices are compared with the same month the year before. So, if, for example, the oil price stays where it is until October, it will be 12pc lower than it was at the same point last year.

The picture on the currency side of the equation is a little bit more complicated, however. The effect of the depreciation was always likely to take a while to filter through.

Many importers, for example, will have currency hedges in place that would have protected them from the initial effects of the pound’s postreferendum plunge, but they don’t last forever.

And the inflated costs of many raw materials take a while to work themselves through the supply chain and manifest themselves in more expensive end-products. Many economists had predicted that inflation would peak later this year, possibly at, or slightly above, 3pc, before starting to ease back again in 2018.

But there is an even more worrying explanation.

Core inflation was also weaker than expected. Some economists have warned that this may be the first, faint indication that an economic slowdown in the UK is putting downward pressure on inflation. This would be the worst possible scenario; we want inflation to fall but not for the wrong reasons.

And, of course, 2.6pc is still way above the average level of wage growth, of 2pc, in the three months to May. The latest figures suggest that British workers and savers are not being as tightly squeezed as they were earlier in the year, but they’re still being squeezed.

The hope is that even if the latest figures don’t indicate a peak in inflation, they do at least suggest it’s coming and that prices will drop back pretty quickly thereafter. Producer input price inflation, which measures the cost of raw materials being fed into the production line, is also starting to fall.

Ruth Gregory, the UK economist at Capital Economics, said that all the evidence was pointing to the possibility that the squeeze on consumers’ real incomes will be “nowhere near as large [n] or as long-lasting as it was after sterling’s last major depreciation in 2008”.

Here’s hoping she’s right. ben.wright@telegraph.co.uk

‘The Bank arguably never needed to raise interest rates to head off inflation, rather it just had to sit on its hands’