UK Inflation Uptick Clouds BoE Outlook, GBP/USD Eyes $1.35 Breakout

UK Inflation Rate Rises in July, Tempering BoE Rate Cut Expectations

UK inflation accelerated in July amid slowing wage growth, fueling stagflation concerns.

The UK’s annual inflation rate (headline) rose from 3.6% in June to 3.8% in July, while core inflation increased at 3.8% (June: 3.6%). Consumer prices also unexpectedly rose by 0.1% month-on-month (June: 0.3%).

Key Data from the Office for National Statistics included:

• The Consumer Prices Index, including owner-occupier housing costs (CPIH), increased 4.2% in the 12 months to July after rising 4.1% in June.
• The largest upward contribution came from transport, particularly air fares, offsetting a downward contribution from housing and household services.
• The Core CPIH (excluding energy, food, alcohol, and tobacco) rose by 4.2% in the 12 months to July, down from 4.3% in June.
• The CPI services annual rate accelerated to 5% in July, up from 4.7% in June.

UK Economic Indicators Keep BoE in Policy Holding Pattern

The inflation report followed last week’s UK GDP figures and mixed labor market data.

Average earnings, including bonuses, increased by 4.6% year-on-year in June after rising 5% in May. Softer wage growth could curb spending and dampen demand-driven inflation.

However, better-than-expected GDP numbers suggested the BoE could delay further monetary policy easing. The UK economy expanded 0.4% in June after contracting 0.1% in May. Quarter-on-quarter, the UK economy grew 0.3% in the second quarter, slowing from 0.7% in the previous quarter. The quarterly number raised concerns about slowing growth amid persistent inflation.

James Smith, Research Director at the Resolution Foundation, remarked:

“Overall, then, Q2 GDP was better than many feared. Growth hasn’t been too bad this year and Rachel Reeves will tout the UK’s good relative position in the G7. But clearly stagnation remains a huge problem with the risk of growth downgrade looming over the Autumn Budget.”

Last week’s labor market and GDP data followed the Bank of England’s 25 basis point rate cut to 4%. However, a 5-4 vote in favor of cutting rates underscored the Monetary Policy Committee’s divided stance on inflation and the labor market.

Today’s inflation figures reduce the likelihood of another cut in September, but economists still anticipate one additional reduction in 2025. ING Economics discounted the latest GDP report:

“We doubt the Bank will take too much inference from the stronger second quarter growth performance. At the very most, it might bolster the arguments of the hawks who are pushing for a slower pace of rate cuts from now on. But in practice, this will much more heavily depend on forthcoming inflation and jobs data.”

Looking ahead, ING Economics added:

“We certainly expect the GDP figures in the second half of the year to have a weaker flavour to them. The jobs market is under pressure; payrolled employment has fallen in eight out of the last nine months.”

Whether the BoE will ease rates in November or December will hinge on the next round of CPI and labor market data. For now, the July data gives the hawks a stronger voice.

GBP/USD Volatility Post-Inflation Data

Ahead of the inflation report, the GBP/USD briefly climbed to a high of $1.34927 before falling to a low of $1.34616. Following the report, the pair briefly slid to a low of $1.34757 before surging to a high of $1.34980.

On Wednesday, August 20, the GBP/USD was up 0.01% to $1.34907, reflecting reduced market bets on a September BoE rate cut.

Looking Ahead

Traders now turn to August’s flash private sector PMIs set for release on August 21. Given that the services sector accounts for over 70% of the UK GDP, a sharp drop in the Services PMI may lift the chances of a November rate cut. However, traders should also consider crucial sub-components, including prices and employment PMIs.

Softening input and output prices and job cuts would support a more dovish BoE rate path, weighing on the GBP/USD pair.

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