The Bank of England faces a setback in its fight against high inflation this week. It is expected to raise interest rates for the first time this year, underscoring the pressure from the cost of living crisis.
In a week of major news from the UK economy, official figures on Wednesday are expected to show that inflation returned above the Bank’s 2 percent target in July, partly due to rapidly rising prices for flights, package holidays and hotels.
City economists said headline inflation is expected to rise to 2.3 percent, after previously remaining at the 2 percent target for two consecutive months in May and June. This would be the first increase since December 2023.
These predictions come after the fall in energy prices for households was smaller in July compared to the same month last year, when prices fell sharply, meaning that the inflation rate will rise year-on-year.
Analysts said that while inflation in services prices was slowing, price growth in this dominant sector of the British economy was expected to remain above 5 percent, boosted by airfares, package holidays and hotel prices.
There has already been a sharp rise in single-night prices this year, partly due to new seasonal patterns since Covid lockdowns were lifted, and hotels are introducing price increases in response to increased demand – including around UK tour dates of stars such as Taylor Swift and Pink.
Rob Wood, chief UK economist at consultancy Pantheon Macroeconomics, said: “The ONS only looks at around 100 hotels, which means outliers such as a Welsh hotel price in June being pushed up by demand for a Pink concert can distort the figures. But some hotel price inflation is real.”
The rise in headline inflation will come after the Bank of England cut its base rate earlier this month for the first time since the start of the Covid pandemic, easing some pressure on households by cutting it from 5.25% to 5%.
Inflation has fallen sharply from a peak of 11.1% in October 2022 after the Russian invasion of Ukraine triggered an explosion in energy prices.
Threadneedle Street warned that inflation is likely to rise to around 2.75% in the second half of the year, driven by price increases in the services sector and a robust UK labour market. However, the institute forecasts that these inflationary pressures will gradually ease, with headline inflation rising again to 1.7% in two years and then falling to 1.5% in 2027.
The bank is expected to cut its key interest rate to just under 3.5 percent before the end of 2025. However, given concerns about continued inflationary pressure, care must be taken not to cut borrowing costs too quickly or too sharply, said bank chief Andrew Bailey.
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Official figures on Thursday are expected to show that the economy continued to recover from recession in the three months to the end of June. City analysts expect growth of 0.7 percent for the second quarter – the same level as the first quarter.
However, the labour market figures published on Tuesday are likely to indicate a slowdown in the labour market; City analysts are forecasting a rise in unemployment and a slowdown in wage growth.
A separate report from the Chartered Institute of Personnel and Development on Monday showed that UK employers expect pay growth to fall to 3% over the next 12 months, down from the previous estimate of 4% in the first quarter of 2024.
James Cockett, a senior labour market economist at the CIPD, said: “With inflation now at levels that workers can bear, declines in expected pay rises were expected. However, many workers will still feel worse than they did a few years ago.”
