UK inflation rose above the Bank of England’s 2 per cent target in July as prices of video games and toys increased sharply, defying forecasts that it would weaken.
Consumer prices were 2.1 per cent higher than a year earlier, according to the Office for National Statistics, increasing from 2 per cent in June and May. Core inflation, which excludes food, alcohol and energy, rose to 1.9 per cent from 1.8 per cent the previous month.
The increase surprised economists, who had expected a drop to 1.9 per cent, and damped speculation that the BoE would cut interest rates as it presented a potential challenge to the central bank.
“The latest data present a further headache for the Bank of England, who will need to weigh up their next policy move in the context of both rising inflation and weak economic growth,” said Geoffrey Yu, head of UK investment office at UBS wealth management.
The rise followed a sharp drop in sterling driven by Brexit uncertainty, and prime minister Boris Johnson’s promise that the UK would leave the EU on October 31 with or without a deal. However, the ONS said this would have a “lagged effect” on inflation.
Instead, key contributors included prices of video games and toys, which have proved an especially volatile contributor to inflation in recent years and leapt 8.4 per cent, more than any time since the 1980s. Accommodation, clothing and housing costs were also factors.
Upward pressures were partly offset by lower transport prices and domestic fuels, the ONS said.
Economists said the strong labour market and weak pound, which pushes up prices of imports, were potential drivers for inflation not falling as fast as previously forecast. Official data released on Tuesday showed wage growth hit an 11-year high, of 3.9 per cent in the three months to June, compared with 3.6 per cent in the previous period, and figures for job creation were also higher than expected.
“Importantly, wage growth is also at a post-crisis high,” said James Smith, developed markets economist at ING THINK, a branch of the financial services company ING. “Given services make up a sizeable share of the UK inflation basket, and these items tend to be fairly labour-intensive, we’d expect this to add a bit of upside to consumer prices in the medium-term.”
Most economists had predicted that inflation would tick down to below the 2 per cent target toward the end of the year, a fall driven by energy prices, but would increase again into 2020.
“The strength in pay growth and the fall in the pound should ensure that inflation spends most of its time above the 2 per cent target in 2020,” said Ruth Gregory, senior UK economist at consultancy Capital Economics.
The Bank of England’s August inflation report also forecast rates would fall to a three-year low of 1.6 per cent in the last quarter of 2019 before rising to 2.4 per cent across a three-year horizon, while warning of a one in three chance of the economy shrinking at the start of next year.
But while the US Federal Reserve and European Central Bank cut interest rates, the Bank of England has opted to hold rates at 0.75 per cent while signalling that a rise would eventually be needed to hold inflation at the 2 per cent target.
The forecast, however, assumes an orderly Brexit and a recovery in global economic growth. The BoE’s Monetary Policy Committee has indicated that in a no-deal Brexit scenario borrowing costs could shift in either direction.
Ms Gregory said the figures would “do little” to change the view that interest rates would be raised following a Brexit deal. “It is only in a no-deal scenario that we think the MPC would cut rates, perhaps from 0.75 per cent to at least 0.25 per cent,” she said.