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Another interest rate rise? News on prices and wages may decide

There is a firm view in the City that Bank of England policymakers have at least one more interest rate rise in them, but much depends on the latest official prices data – out this week – and how quickly inflation is falling.

Financial markets are betting that there is a 80% chance of a 0.25 percentage-point rise, to 5.5%, when the Bank’s monetary policy committee (MPC) next meets on 21 September.

The central bank is under pressure to bring down inflation to its 2% target after a jump in the consumer prices index (CPI) to more than five times that last year. While the UK annual inflation rate slowed to 7.9% in June from 8.7% the previous month – many City economists were surprised at the scale of the drop – the pace of price rises remains faster in the UK than in most industrialised nations.

In France the inflation rate is 5.3%, in Germany it is 6.8% and the eurozone average is 5.5%. Meanwhile, US inflation is bouncing around the 3% mark – figures last week showed a slight rise, to 3.2%, in July.

Huw Pill, an MPC member and the Bank’s chief economist, recently said he believed its 14 consecutive interest rate rises – to the highest level in 15 years – were working. He meant that the soaring cost of borrowing was persuading businesses and households to rein in spending.

In its latest report, the Bank forecasts that inflation will fall to below 5% by the end of the year, based on interest rates peaking at 6%. But analysts told the Observer they believed a 5.5% peak could be more than enough to achieve this target.

Samuel Tombs, economist at Pantheon Macroeconomics, expects inflation in July to drop to 6.8% after the cut by Ofgem in the energy price cap that took effect on 1 July.

The cap, which limits what suppliers can charge per unit of gas and electricity, is equivalent to £2,074 a year for a typical household that buys its gas and electricity from the same supplier – down from £2,500 under the government’s energy price guarantee.

Tombs says petrol and diesel prices, which have fallen steeply since last year, have also been helping to bring inflation down, though that trend will continue only for another month.

At the Bank, Pill will also be watching the labour market figures next week and especially data on earnings. Analysts were surprised last month when the figures for May showed average pay jumping by 7.6%, driven by a 9.2% increase in the earnings of workers in the finance and business services sector.

The Bank expects to find that earnings have accelerated to a level where they outpace inflation. At its last meeting, the deputy governor, Ben Broadbent, said he thought the leap in wages growth meant the era of falling living standards was over.

He said it was a worry for the Bank if wages growth remained high, because that would become a feedback loop into prices again. However, wages data only reveals what was happening six months or more ago, when wage deals were struck.

Sandra Horsfield, senior economist at Investec, expects inflation to fall to 4% by the end of the year and keep falling, with wage rises decreasing at the same pace. Her main fear centres on the febrile global energy markets, which could send prices rocketing again, even without an escalation of the war in Ukraine.

European gas prices shot up 30% last week after 700 workers in Western Australia threatened to strike, potentially closing processing plants capable of exporting about 10% of the world’s liquefied natural gas. A deal is expected, but the implications were not lost on Horsfield, who says it is a warning to those who believe the UK has solved its inflation problem.

Rail ticket prices for next year may also deal a blow to inflation forecasts when they are calculated this week. The government uses the July retail prices index to set rail prices for the following January. In June, RPI was 10.7% and is expected to fall only slightly in July, putting further pressure on inflation in 2024.

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