UK inflation shock: Where now for interest rates as cost-of-living hits near 18-month high

News of an unexpected and unwelcome uptick in inflation will rattle Bank of England policymakers and cloud the outlook for future interest rate cuts.

Official statistics revealed that the annual measure of consumer prices index (CPI) inflation rose to 3.6 per cent in June, up from 3.4 per cent in May and the highest reading in almost 18 months as food prices rose for the third month running.

The increase in the headline inflation rate surprised economists who had been expecting it to remain unchanged at 3.4 per cent.

Shoppers will have noticed the cost of some food items continuing to rise. Picture: Greg Macvean

The Office for National Statistics (ONS) said annual food price inflation hit the highest level since February 2024, while transport costs and a spike in oil prices also pushed up the cost of living. Consumers will have noticed several items in their shopping trollies continue to rise, though other products have stabilised and a few have even eased since food price inflation peaked well into double-digit territory in early 2023.

The surprise increase in inflation will be watched closely by the Bank of England ahead of its next interest rate decision on August 7. While the central bank’s nine-strong monetary policy committee (MPC) is widely expected to trim rates again next month, from 4.25 per cent to 4 per cent, given a slowing wider economy, the latest unexpected rise in inflation may see policymakers tread cautiously further out.

Peter Stimson, director of mortgages at lender MPowered Mortgages, said the “intake of breath at the Bank of England will have been audible” as he warned that mortgage rates could nudge higher in the coming weeks.

“Inflation like this can no longer be dismissed as a blip. It’s now a barrier to cutting interest rates,” he said. “While the weakness of the economy means the Bank of England will be keen to resume rate cuts in coming months, the likelihood of an August cut has plunged from near certain to barely 50/50. This is likely to cause a shift in the swap rates which determine mortgage interest rates.

The outlook for future interest rate cuts from the Bank of England, above, has become more cloudy.

“Mortgage rates may well have fallen as far as they can for now, and in the coming weeks rates may even creep back up as lenders recalibrate in response to rising swap rates.”

Sarah Coles, head of personal finance at investment platform Hargreaves Lansdown, said a reduction in borrowing costs at the start of August was “still likely to be on the cards”.

She added: “Mortgages and savings rates are already on their way down, as the markets price in an August cut, and then another later in 2025. Day-to-day we’ve seen rates wavering, but over time they’re trending south. Annuities have inched down, but continue to deliver decent incomes.”

Coles said food and drink prices were “eating away at our spending power”, noting that part of the problem was higher national insurance payments for employers being passed on as suppliers and supermarkets cover higher costs.

Within transport costs, the ONS said air fares soared by 7.9% between May and June, marking the biggest rise since 2018.

Beyond August’s meeting, the MPC is due to gather on three more occasions before the end of the year - September 18, November 6 and December 18.

Rob Clarry, investment strategist at Evelyn Partners, the UK wealth manager, said the UK continued to face “stickier inflationary pressures” compared with other advanced economies.

“This is arguably reflected in the bond market with gilt yields remaining higher than their European counterparts, despite the UK facing a similarly weak growth profile,” he noted.

“[The inflation report] complicates the outlook for the MPC, although traders continue to expect two further 25 basis point [quarter point] interest rate cuts this year.”

The inflation figures come after UK gross domestic product (GDP) shrank by 0.1 per cent in May, following a 0.3 per cent fall in April and leading to fears of a contraction overall in the third quarter.

Jobs figures this week are expected to show a further slowdown in wage growth, which may help smooth the path for an interest rate cut.

The latest ONS data showed food and non-alcoholic drink price inflation lifted to an annual rate of 4.5 per cent in June, up from 4.4 per cent in May.

Taking off

Within transport costs, the ONS said air fares soared by 7.9 per cent between May and June, marking the biggest rise since 2018. Rail fares also rose month-on-month, having fallen a year earlier, while fuel prices fell only slightly last month compared with a larger fall a year ago.

Hargreaves Lansdown’s Coles said: “Air fares continued to surprise. This is a common seasonal trend, but was much more striking this year, with the biggest June rise since 2018.

“Prices took off on long-haul and European routes in particular. It appears that wages rising considerably ahead of inflation has encouraged us to jet off this year.”

The average price of petrol fell by 0.5 pence a litre during June, compared with a drop of 3p a litre between May and June 2024.

Elsewhere, the data showed the ONS’s preferred measure of inflation, consumer prices index including owner occupiers’ housing (CPIH), lifted to 4.1 per cent last month from 4 per cent in May. Meanwhile, the retail prices index (RPI) rate of inflation rose to an annual 4.4 per cent in June from 4.3 per cent in May.

Chancellor Rachel Reeves said there was “more to do” to help bring inflation down. She added: “I know working people are still struggling with the cost of living.”

Interest rates: Hold for now but cheaper mortgages could be just weeks away