UK inflation shock: What does a jump in prices mean for interest rates and my finances?

The annual rate of inflation may have risen for the first time this year, following months of steady declines, but the overwhelming messaging around the uptick is clear: “Don’t panic”. Well, at least not for now.

Consumer prices index (CPI) inflation nudged up to 2.2 per cent in July, from 2 per cent in June, marking the first increase in the closely-watched measure since December. The rebound was driven partly by a sharp drop in energy bills last July falling out of the year on year calculations.

When it voted to cut interest rates for the first time in more than four years on August 1, the Bank of England warned that the fall-away of energy bills in the wider inflation figures would show “more clearly the prevailing persistence of domestic inflationary pressures”. The latest inflation data means that prices are rising faster than in previous months, but still at a slower rate than in 2022 and 2023 when households and businesses were being squeezed during the peak of the cost crisis. CPI peaked at 11.1 per cent in October 2022.

The uptick in headline inflation in July 2024 was driven partly by a sharp drop in energy bills last July falling out of the year on year calculations.

The central bank’s rate-setting monetary policy committee (MPC) will make its next decision in September, and most economists predict that rates will be held at 5 per cent, having been trimmed by a quarter point to that level at the start of August. Despite that, markets have now increased bets on a base rate cut in September due to improvements in core and services inflation.

Suren Thiru, economics director at accountancy body ICAEW, said the inflation increase signalled the start of a period of “moderately rising price pressures”, with greater demand from a recovering economy and higher energy bills likely to keep inflation above the Bank of England’s 2 per cent target until next year.

He added: “These figures mean a September rate cut is improbable and will likely lead to a definitive, possibly unanimous, vote among rate setters in favour of keeping interest rates on hold.”

Peter Stimson, head of product at MPowered Mortgages, was in agreement, saying: “With headline inflation back above target, a base rate cut in September is now likely off the cards. However, there’s still the possibility for a cut before the year is out in what remains a highly fluid market.

The rate of food price inflation has been easing for some time now with the cost of some products actually falling.

“Even though inflation has risen, there is unlikely to be an impact on mortgage rates as this has already been priced in. Swaps rates, which lenders use to price fixed-rate mortgages, fell quite significantly in the days after this month’s base rate cut and even further following the weak non-farm payrolls data and fears of a US recession.”

Luke Bartholomew, deputy chief economist at Scottish funds giant Abrdn, noted that July’s inflation uptick was slightly smaller than expected - many analysts had been expecting a figure closer to 2.4 per cent.

“Despite the pick-up in headline inflation, this report represents welcome news for the Bank of England,” he said: “More importantly, measures of underlying inflation pressure look to be softening, with services inflation in particular coming in well below expectations. This should help reassure some policymakers that inflation pressures are proving slightly less persistent than feared. After yesterday’s solid labour market report, the Bank will not be in any hurry to cut rates again immediately, but the ongoing slowing in inflation pressure means there is certainly scope for at least one more rate cut this year.”

On a positive note, the annual rate of CPI services price inflation - closely watched by the MPC - fell sharply to 5.2 per cent in July, down from 5.7 per cent in June, marking its lowest level since June 2022. Experts have warned that persistently high services price inflation could risk pushing the overall inflation data up further, but the drop should provide some encouragement to policymakers. The core rate of inflation also eased last month.

Ed Monk, associate director for personal investing at Fidelity International, said: “A rise in the headline rate of inflation is less important than a slight easing in core inflation - down from 3.5 per cent to 3.3 per cent - which suggests the trajectory for price rises is still downwards.”

So, what do the latest inflation numbers mean for savings and mortgages? For savers, it brings some positive news in the short term as the best cash savings rates on the likes of fixed-period bonds and ISAs remain well ahead of inflation. However, the overall trajectory for savings rates is downwards, now that the Bank of England has embarked on a monetary easing programme.

Sarah Coles, head of personal finance at investment platform Hargreaves Lansdown, said: “The most competitive one-year fixed rate and easy access accounts are hanging on above 5 per cent, but every other market has dropped below, and there’s only so long the hold-outs can cling on. For a lot of people, a pick-and-mix approach works, using different banks, savings accounts and cash ISAs for different periods, to build the savings mix that suits them best.”

On mortgages, Coles noted: “Mortgage borrowers on tracker rates are likely to have to wait for the next cut in their monthly payments. It was always going to take longer for rates to unwind than they did to build, but those whose finances are stretched to breaking point could be forgiven for getting increasingly impatient.

“For those looking for a new fixed rate, or with a remortgage looming, the news is better. Mortgage rates have eased in recent weeks. They may well drift further south in the coming weeks.”

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