UK reaction: Still at target, but services remains sticky.

Headline inflation remained at the 2% target in June – in line with the MPC’s forecast, though slightly above the 1.9% expected by analysts – but sticky services inflation remains a problem. We still think the Bank of England will push ahead with the first rate cut in August’s meeting in a couple of weeks, but the call will be on a knife-edge. Goods CPI inflation continue to drive down the headline rate, falling to an annual -1.4% - the sharpest drop since May 2016 – from -1.3% in May. Within this, food inflation slowed for the 19^th month in a row, falling to 1.5% in June – its lowest rate since October 2021 – from 1.7% in May. Clothing also added to the downward pressure, with the relative inflation rate falling to 1.6%, from 3%. Cooler, wetter weather has meant consumers have postponed the purchase of summer clothing, with the ONS noting a higher degree of discounts than in June 2023. A smaller decline in second-hand car prices this year, compared to last and a rise in motor fuel price inflation to 2.6%, from 2.3% in May, however, applied some upward pressure.

The key for the MPC, which is concerned about the persistence of inflation once the current down draft from energy prices recedes, is services inflation and that was sticky, unchanged at 5.7% and well above its 2015-19 average, 2.5%. That largely reflected upward pressure from hotel prices which jumped by 8.8% on the month in June 2024, compared to 1.7% in the same month in 2023. This is probably partially due to the series of Taylor Swift concerts that took place in June and is therefore unlikely to be repeated in July. Restaurants and hotels CPI inflation rose to 6.2%, from 5.8% as a result, adding 0.07 percentage points to the rate, though it would have held broadly steady if accommodation services rose as normal. Note that the Bank of England’s underlying services measure excludes hotel prices. By contrast, recreation and culture CPI inflation remained unchanged at 3.9%, its lowest rate since January 2022, and communication CPI inflation fell to 2.9%, from 4.1%.

The headline rate will rise above 2% again in July, as the sharp declines in energy prices in 2023 will not be repeated this year. Goods CPI inflation, however, should continue to tick down, due to further declines in food CPI inflation and non-energy industrial goods inflation. In addition, services CPI should start to fall more materially, now that the near-10% increase in the National Living Wage has fed through and also partly due to base effects following chunky increases in 2023.

The big question, though, is what this means for the Bank of England. The more hawkish members – Pill, Mann, Haskel and Greene – were always unlikely to vote for a cut in August regardless of these data. But there is a risk that the stubbornness of services inflation will put off those members close to changing their vote, namely Bailey and Breeden. It will be close, but the MPC has continued to highlight the importance of a broad range of data, including the Bank’s Decision Maker Panel which showed a further moderation in respondents’ expectations for both price and wage growth. Tomorrow’s labour market data are also key; members will be keen to see wage growth slowing in the months following the NLW hike. Recent sterling strength, meanwhile, will also leave the MPC more confident that inflation will drop back to target over the medium term. We think these data will be just enough to tilt the balance in August, but it will be close; we look for a vote split of 5:4 in favour of a cut.