UK inflation drops more than expected

UK inflation fell back more than forecast in July. Headline CPI was flat in July and fell back to +2.0% for the year (down from +2.5% in June). This was lower than the expected decline to +2.3%. Core CPI also fell back more than expected to +1.8% (+2.2% exp, +2.3% in June).

The main driver of the decline was in clothing and footwear, which traditionally see a decline during the summer sale season. This decline cut -0.1% off total inflation as prices of clothes and footwear fell by -2.0% on the month (compared with a decline of just -0.7% last year).

For months, the big question for most major economies is whether the post-pandemic inflation spikes would prove to be transitory. Consumer inflation in the UK falling back sharply in July fits into this category. The UK’s economic restrictions eased in July 2020 after the first wave of COVID and this base effect has now caused this decline in July 2021. Inflation is likely to be choppy in the coming months as a result.

Furthermore, we still see input prices at elevated levels, as the PPI Input Prices increased once more to +9.9%. This was more than markets had been expecting and goes a little way towards balancing out the CPI decline. High contributions of oil prices, metals and chemicals are still a key factor for producers to incur. This should help to ensure that inflation pressures remain elevated in the coming months.

What does this mean?

UK inflation is likely to be choppy in the coming months as the base effects of COVID restrictions in 2020 play out. Producer Prices remain high and this will contribute to elevated pricing pressures. Pressure on the Bank of England to increase interest rates will have eased as a result of today’s data but there is an uncertainty surrounding the data.

Initial Market Reaction

GBP has been choppy on this data. Lower than expected CPI came with higher than expected PPI help to balance the impact. GBP/USD fell c. -10 pips and has since recovered.