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The UK’s annual inflation rate fell unexpectedly in August to 6.7% despite a sharp rise in average fuel prices for motorists, easing some of the pressure on the Bank of England to raise interest rates.
In a crunch week for the economy, the Office for National Statistics said slower increases in the cost of food helped the annual inflation rate as measured by the consumer prices index drop for the sixth month in a row from a reading of 6.8% in July.
The surprise fall in the inflation rate to its lowest level since February last year confounded City expectations for a modest increase to 7%, while the chancellor, Jeremy Hunt, had also expected a “blip” in the downward path for inflation fuelled by higher petrol and diesel prices.
Economists said the figures could leave the Bank of England’s next call on interest rates on Thursday on a knife-edge. Markets had been forecasting the Bank would make a 15th and final increase in borrowing costs in its most aggressive tightening cycle for decades but after Wednesday’s inflation release they moved to a roughly even split on whether there would be a rise.
Falling prices for hotels and air fares compared with July helped pull down August’s headline inflation rate, while food prices rose by less than at the same time last year. This was offset partly by the growing cost of petrol and diesel, amid a sharp rise in global oil prices.
The reduction in the inflation rate does not mean that prices are falling, only that they are rising at a slower pace. While the rate of increase for the cost of food and drink cooled sharply, prices were still 13.6% higher in August compared with a year earlier, down from a peak annual rate of about 19% earlier this year.
The ONS said the largest impact on food and drink inflation was from milk, cheese, and eggs, where prices fell sharply between July and August but was still up by about 15% compared with a year ago. The cost of vegetables, as well as fresh, chilled and frozen fish and seafood, also fell on the month.
Core inflation – which excludes energy, food, alcohol and tobacco – fell by more than expected, from 6.9% in July to 6.2% in August, driven by lower services prices. Figures for core inflation and the service sector are watched closely by the Bank when determining interest rates.
Threadneedle Street had said last month it expected inflation to rise slightly in August before falling sharply to about 5% in October. The pound fell on global currency markets after the August inflation data release, while financial markets cut the probability of a rate rise on Thursday from about 80% to 55%.
James Smith, an economist at the Dutch bank ING, said: “We’re still tempted to say the Bank of England will hike rates tomorrow. But it’s a close call, and both wage and inflation data suggest the end of the current tightening cycle is very close to its conclusion.”
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Hunt said the latest inflation figures showed the government’s plan was working. “But it is still too high, which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses. It is also the only path to sustainably higher growth,” the chancellor said.
However, the UK remains an international outlier, with the highest inflation rate among G7 economies.
Rachel Reeves, the shadow chancellor, said: “The prime minister is too weak to turn things around, while his predecessor Liz Truss continues to call for the same policies that crashed the economy this time last year.
“The Conservatives have wreaked havoc and working people are paying the price.”
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