First UK inflation increase of year forecast in setback for Bank of England

The Bank of England is poised for a setback in the battle against high inflation this week amid expectations for a first increase in the headline rate this year, highlighting the pressure from the cost of living crisis.

In a week of key updates from the British economy, official figures on Wednesday are expected to show inflation returned above the Bank’s 2% target in July, driven in part by fast-rising prices for air fares, package holidays and hotels.

City economists said headline inflation was on track to increase to 2.3%, having previously held steady at the 2% target for two consecutive months in May and June, in what would mark the first increase since December 2023.

The predictions come after a smaller decline in household energy prices in July compared with the same month a year ago, when prices fell sharply, meaning that the year-on-year inflation rate is set to increase.

Analysts said that while inflation in services prices was slowing, price growth in this dominant sector of the British economy was on track to remain above 5%, fuelled by air fares, package holidays and hotel prices.

It comes after a sharp rise in the price of one-night stays this year, partly reflecting new seasonal patterns since the lifting of Covid lockdowns, and as hotels deploy surge pricing to respond to increases in demand – including around UK tour dates for stars including Taylor Swift and Pink.

Rob Wood, the chief UK economist at the consultancy Pantheon Macroeconomics, said: “The ONS surveys only about 100 hotels, which means outliers, such as a Welsh hotel price in June boosted by demand from a Pink concert, can distort the figures. But some hotel price inflation is genuine.”

The rise in headline inflation will come after the Bank of England cut interest rates earlier this month for the first time since the start of the Covid pandemic, easing some of the pressure on households with a reduction from 5.25% to 5%.

Inflation has fallen back sharply from a peak of 11.1% in October 2022 after Russia’s invasion of Ukraine triggered an explosion in energy prices.

Threadneedle Street has warned that inflation is likely to rise to about 2.75% in the second half of this year, driven by service sector price rises and a resilient UK jobs market. However, it forecasts these inflationary pressures will gradually fade, taking headline inflation back to 1.7% in two years’ time, before a fall to 1.5% in 2027.

The Bank is expected to cut its base rate close to 3.5% before the end of 2025. However, Andrew Bailey, the Bank’s governor, has said that it will need to be careful not to reduce borrowing costs too quickly or by too much, amid concerns over lingering inflationary pressures.

Official figures on Thursday are expected to show the economy continued to recover from recession in the three months to the end of June, with City analysts pencilling in growth of 0.7% in the second quarter – the same pace as the first quarter .

However, figures from the jobs market on Tuesday are expected to show a cooling jobs market, with a rise in unemployment and a slowdown in wage growth forecast by City analysts.

A separate report from the Chartered Institute of Personnel and Development on Monday shows UK employers’ anticipate wage growth for the next 12 months will fall to 3%, down from a previous estimate of 4% made in the first quarter of 2024.

James Cockett, a senior labour market economist for the CIPD, said: “Falls in expected pay rises were anticipated now inflation is within a tolerable range for employees. However, many workers will still feel worse off than they did a couple of years ago.”