Persistently high services inflation in the UK is dampening hopes for faster interest rate cuts from the Bank of England (BoE), despite mounting pressure from a weakening labour market. The latest data shows headline inflation rising to 3.6% in June, while services inflation held firm at 4.7%, defying expectations of a decline.
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Services inflation, a critical measure for the BoE, appears increasingly stubborn. According to ING's analysis, 'Our metrics of "core services" generally picked up in June,' driven by unexpected rises in rail fares and accelerating catering prices, sectors that account for a significant portion of the inflation basket.
These price pressures may be linked to recent policy changes. 'That may be related to the National Insurance hike on employers, as well as the hefty rise in the National Living Wage,' ING noted. Although some of the increase is due to regulated or backwards-looking price categories, such as the April rise in road tax and caps on social housing rents, their influence is expected to wane in the coming months. 'Rents are also adding close to a percentage point, but this contribution is set to almost halve over the course of the next few months.'
Still, the overall stickiness in inflation sets a "fairly high" bar for the Bank to accelerate monetary easing. ING economist James Smith explains: 'The fact that so much of the services basket is reset only once per year in April means services inflation will struggle to move significantly lower before next spring. But by then, we think it will be much closer to 3% than 4%.'
With inflation edging toward 4%, the BoE faces a delicate balancing act. BoE Chief Economist Huw Pill recently warned that 'inflation has a habit of becoming more entrenched when CPI reaches these levels,' citing internal research. However, ING remains sceptical this holds true under current conditions, pointing instead to the faltering jobs market as a potential driver for change.
'Thursday's payroll data is absolutely key,' Smith adds. 'If May's shockingly bad figures aren't revised up and/or if June's numbers are as bad, that could be a catalyst for the Bank to rethink its current cautious approach to rate cuts.'
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