UK inflation in surprise fall

July 25, 2017

The fall in the UK inflation rate for June, announced last week, took many economists by surprise. The headline annual rate fell from 2.9% in May to 2.6%. The drop was driven by lower fuel costs as well as the significant year on year drop in the pound beginning to fall out of the annual figure. However, most commentators are not anticipating that this is the peak and there will be several more months of higher inflation, potentially breaching 3%, before beginning to fall back. Nevertheless, the weaker figures dampened expectations that there might be an interest rate rise from the Bank of England in the near future and as a result, there was a slight fall in the pound. The fall in the rate of inflation will be better news for the consumer, as it lessens the strain on real incomes which are now falling less quickly. Weakening growth in producer input and output prices are indicating that there will be downward pressure on inflation over the coming year.

 

Government borrowing increased last month from a year earlier, marking a turnaround from the narrowing deficit seen during the previous government. While tax receipts have been increasing, government expenditure rose at a faster rate. One of the primary drivers of this increase was a higher cost of borrowing for index linked gilts. This will limit the scope for Philip Hammond to increase spending in the next budget. As a result, tight fiscal policy is likely to remain a drag on economic growth for the foreseeable future. Furthermore, the government is now much more sensitive to interest rates and inflation as the total debt burden is significantly higher than it was before the financial crisis.

 

Elsewhere, the Euro has continued to deliver strong gains over major currencies as the European economy improves, political risk reduces, and investors rush to rebuild exposure to the continent’s assets. The currency is up over 11% since the start of the year against the US dollar, although it is still significantly below the levels seen in 2014. As a result, many are anticipating that this is the beginning of a strong rally for the Euro. However, its progress could be easily derailed by a slower than anticipated tapering by the European Central Bank or a weakening of the economic momentum.

 

Index Open Close Change % Change
FTSE 100 7378 7452 74 1.00%
S&P 500 2449 2473 24 0.98%
Dax 12631 12240 -391 -3.10%
Cac 40 5235 5117 -118 -2.25%
Nikkei 225 20099 19975 -124 -0.62%
UK 10 Year Gilt Yield 1.289 1.18 -0.109 -8.46%

 

UK preliminary GDP figures will be announced on Wednesday as well as the Federal Reserve interest rate announcement. On Friday Japanese inflation and unemployment figures will be released.