UK inflation slowdown eases pressure on Burnham government and Bank of England

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UK inflation slowdown eases pressure

Highlights

UK inflation fell to 2.6 per cent in June, below forecasts, reinforcing expectations the Bank of England will hold rates at 3.75 per cent.
Annual private-sector wage growth excluding bonuses dropped below 3 per cent for the first time in five years, with employment and hiring remaining flat.
Analysts warn rising European gas prices could push UK inflation to a 3.5 per cent peak early next year, exacerbating fiscal and household pay pressures.

June inflation data reshapes rate outlook

As reported by Financial Times, UK inflation falls to 2.6 per cent in June, below City forecasts, reinforcing investor expectations that the Bank of England may be able to keep rates on hold rather than raise them from 3.75 per cent.

Investors and economists say the softer reading, combined with subdued services inflation and weaker wage growth, improves the chances that the BoE's next move could eventually be a rate cut. Benjamin Jones, global head of research at Invesco, says the Burnham government could "get a bit lucky," while James Smith at ING says the latest drop in food and petrol prices should help contain inflation expectations.

Food price inflation slows to 1.7 per cent in June from 4.5 per cent a year earlier, reaching its lowest level since the summer of 2024. Separate labour market data also show annual private-sector wage growth, excluding bonuses, drops below 3 per cent for the first time in five years in the three months to May, suggesting workers have less bargaining power as hiring remains weak and employment stays flat.

Economists say that combination should give BoE policymakers more confidence to look through the temporary effects of the latest energy shock when they meet next week, provided geopolitical tensions do not worsen sharply. Public sector pay continues to grow faster, rising 5.5 per cent from a year earlier, but the central bank places greater weight on private-sector pay as an indicator of domestic inflation pressure.

Energy risks and fiscal strains still weigh

The improved inflation picture does not remove the broader economic pressures facing Burnham and chancellor John Healey. Analysts warn that renewed gains in European gas prices are likely to push inflation higher later in the year, with Paul Dales of Capital Economics forecasting price growth will peak at 3.5 per cent early next year.

That outlook means more households could still see real pay squeezed, even after the latest relief in headline inflation. Bruna Skarica, chief UK economist at Morgan Stanley, says a more persistent inflation overshoot from an external shock would mainly need to come through the labour market, and for now there is no evidence of a renewed turn in UK pay pressures.

Burnham's initial measures, including the removal of VAT on electricity bills and a cap on bus fares, are seen by analysts as relatively low-cost steps aimed at addressing voter concerns after five years of inflation above the BoE's 2 per cent target. Even so, investors remain cautious because of the UK's fiscal challenges, weak growth prospects and rising defence funding needs, leaving markets in what Jones describes as a wait-and-see mode.

Our earlier coverage of the UK’s lower-than-expected June inflation reading outlined how the drop to 2.6%—alongside cooling food prices and softer private-sector wage growth—eased immediate pressure on the Bank of England to raise rates and strengthened the case for holding steady with an eye to potential cuts. It also noted that the outlook remains vulnerable to renewed energy-price shocks, with higher European gas costs flagged as a key risk that could push inflation back up and squeeze real incomes despite early fiscal measures.

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