UK inflation shock: What the 3.8% rate means for interest rates, savings and mortgages

The latest hike in inflation is a fresh blow for UK households grappling with rising bills and is almost certain to delay any further cut in interest rates.

The annual rate of inflation rose by more than expected in July as strong demand for summer travel pushed up air fares and the prices of many food essentials continued to climb.

The consumer prices index (CPI) came in at 3.8 per cent last month, up from 3.6 per cent in June, the Office for National Statistics (ONS) said. Most economists had been forecasting a July inflation reading of 3.7 per cent.

Inflation is continuing to eat into the savings of millions of Brits.

It’s a worrying trend for the Bank of England, which had been expecting CPI to continue rising to a peak of 4 per cent in September, before price rises start to ease. That forecast could prove rather optimistic on the current trajectory as rate-setters attempt to get inflation back down to the central bank’s target of 2 per cent.

In a further warning signal, the latest ONS data also revealed the annual rate of services CPI inflation rose to 5 per cent in July from 4.7 per cent the month before.

The ONS said transport was the biggest factor driving up overall inflation last month, particularly due to a spike in flight prices as families booked trips during the school summer holidays.

Air fares soared by 30.2 per cent between June and July, the biggest jump since the collection of monthly data began in 2001.

Stuart Morrison, research manager at the British Chambers of Commerce, said the “inflation warning lights continue to flash” as he noted that prices are now rising at the fastest rate since the start of 2024.

“While many firms are desperate to see further interest rate cuts, there’s now growing concern that persistent inflation will limit the scope for further reductions,” he said. “It’s vital that policymakers ease the cost pressures on business. Our message to the Chancellor is clear - no new tax rises on business in the Budget.”

The ONS said transport was the biggest factor driving up overall inflation in July, particularly due to a spike in flight prices as families booked trips during the school summer holidays.

The bank base rate was trimmed to 4 per cent from 4.25 per cent earlier this month, bringing relief to millions of mortgage holders, borrowers and businesses. Analysts expect further gradual rate reductions over the coming year or so, though the pace and extent of those cuts will be dependent upon a range of domestic and global factors, with Bank of England policymakers continuing to face a tricky balancing act.

Professor Joe Nellis, economic adviser at MHA, the accountancy and advisory firm, said the latest rise in inflation dampened hopes of further interest rate cuts this year.

“The increase, driven largely by persistent domestic cost pressures, signals that inflation is here to stay for a while longer,” he noted. “Given these underlying pressures, the [Bank of England’s] monetary policy committee (MPC) will not, and should not, cut interest rates when it next meets in September. Inflation will need to show some sign of improving if we are to see any cut at all before the new year.

“Higher inflation is a worry for the Chancellor in the lead-up to the Autumn Budget. For the financial markets, inflation reflects volatility, pushing up gilt yields and therefore the cost of servicing the UK’s already sizeable public debt. With the fiscal headroom already tight, this threatens to exacerbate the situation the Chancellor finds herself in.”

The next MPC meeting takes place on September 18, with two further gatherings - on November 6 and December 18 - before the end of this year.

This month’s rate cut brought good news for borrowers, with repayments for those on tracker mortgages easing, while an increasing number of lenders are cutting their fixed-term deals in a scramble for business.

On the flip side, savers have seen the rates offered on many products trimmed, leaving them more exposed to savings erosion as inflation climbs.

James Bentley, director at Financial Markets Online, said: “Inflation is running hot and this is taking a blowtorch to the value of millions of Britons’ savings. The annual CPI rate of 3.8 per cent isn’t just an abstract economic number. It means the cost of living is rising three times faster than the interest paid by most bank savings accounts, and this is steadily eroding the value of people’s nest eggs and rainy day funds.”

Mr Bentley added: “While Britain has long been a nation of savers rather than investors, the inability of cash savings accounts to keep pace with inflation is prompting many to look elsewhere.

“This week the FTSE 100 index hit a record high, up 12.4 per cent since the start of the year. This rise is in part due to the steady stream of people opting to invest in shares rather than face the certainty of losing money in real terms if they leave their savings in the bank.”

War

Sarah Coles, head of personal finance at investment platform Hargreaves Lansdown, said the mortgage price war was “well and truly underway”. The average rate over both two years and five years has dropped below 5 per cent for the first time since the toxic 2022 mini-Budget.

“This is less to do with any huge changes in rate expectations,” Ms Coles observed. “It’s all about competition, as banks squeeze their margins wafer thin to pick up business.

“This will be a massive relief to anyone in the market for a remortgage in the near future. Especially those coming off a two-year deal, there’s brilliant news because they could actually see their monthly repayments drop.”