Sharp decline in inflation shakes off pressure on Bank of England to hike rates

 

Supermarket price wars and high street sales combined to drive inflation sharply lower in July, easing the pressure on the Bank of England to press ahead with early interest rate rises.

Threadneedle Street’s official benchmark of inflation, the consumer prices index, eased from 1.9 per cent to a lower than anticipated 1.6 per cent last month, remaining below the Bank’s 2 per cent target for the seventh month in a row.

The Office for National Statistics put the drop down to a third successive month of falling food and drink costs as the UK’s major grocers scrap for shoppers and fend off discount rivals against a backdrop of falling commodity prices.

Promotions from retailers also drove inflation lower as sales have come later in the summer than last year, when companies were forced into early price-slashing by a bitterly cold winter.

Factory gate prices for UK manufacturers meanwhile are lower than a year ago for the first time since 2009 – falling 0.1 per cent in the year to July – due to a plunge in crude oil costs. Brent crude has fallen more than 5 per cent in the last month alone, thanks to increased supply from Libya. 

The sharp drop in the CPI caught the City off-guard, prompting a sell-off of the pound which drove sterling to a four-month low against the dollar. Experts said the lack of evidence of inflation – as well as average wages growing at less than half the pace of the cost of living at 0.6 per cent - would stay the hand of the Monetary Policy Committee from a first rate hike since 2007 this year.

Investec economist Victoria Clarke said: “The mood music playing at present … is that for now, a late-2014 increase in Bank rate appears to be off the cards. The subdued nature of price trends, both at the factory gate and in terms of headline CPI, should serve to buy the MPC some more time.”

“Given that the committee’s  expectation was for CPI to stay at 1.9 per cent, this downside surprise is significant, and could influence  members’ thinking on policy in the near term,” HSCB economist Liz Martins added.

The inflation figures follow dovish forecasts from the Bank of England last week which laid heavy emphasis on weak wage growth and pushed the pound lower.

But Governor Mark Carney sent a more hawkish signal in weekend comments that the Bank may not wait until wages have caught up with the cost of living before pressing ahead with interest rate rises.

Minutes of the Bank’s August meeting, due to be published today, could give another twist in the plot amid speculation of the first split vote on interest rates since July 2011, when a summer of turmoil in the eurozone prompted the Bank to engage on another burst of money-printing.

 Martin Weale and Ian McCafferty, two of the external members of the MPC, are seen as most likely to break ranks with the rest of the committee with a vote for higher interest rates.

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