Background: A tight labor market is fueling inflationary pressures.
Achieving the government’s pledge will not resolve Britain’s inflation problem. The central bank has a mandate to ensure price stability, which is measured as 2 percent inflation.
As in it its European neighbors, inflation in Britain was pushed up by soaring energy prices last year. But as wholesale prices have dropped this year, the benefit has been slow to reach British households, in part because energy price caps are set quarterly by a government regulator.
This partly explains Britain’s relatively high inflation rate — which is higher than in Western Europe and double the rate in the United States — but there are other reasons that inflationary pressures in Britain are strong.
Britain still has more people out of the work force than before the pandemic, unemployment is low and job vacancies are high. Employers are pushing up wages to attract and retain workers. Although most of these pay increases are not keeping up with inflation, wage growth risks becoming a stubborn source of higher prices as companies pass on higher labor costs.
Pay in the private sector rose 7.1 percent in the three months through May compared with a year earlier, a record high outside of the pandemic, when furlough distorted the data.
What’s Next: The central bank is still expected to raise rates.
Despite the lower-than-expected inflation reading, the Bank of England is expected to raise interest rates when policymakers meet in early August.
That’s because the “encouraging” data comes with a caveat, according to economists at Barclays. There was the limited progress on services inflation, which, alongside private-sector wage growth, suggests some persistence in inflation. Together, that warrants more monetary tightening, they wrote in an analyst note.
The economists still expect the central bank to raise rates half a percentage point next month, but said the chances of a quarter-point increase had grown.
The central bank has raised interest rates at 13 consecutive meetings, to 5 percent last month, from 0.1 percent in late 2021.
Investors tempered their expectations on Wednesday for rate increases. Previously, they bet that interest rates would peak above 6 percent, but now markets imply that rates will climb to about 5.8 percent by the end of the year.
Any decline in rate expectations will be good news for mortgage holders, who need to renew the terms on their fixed-rate loans and are facing increases of hundreds of pounds in their monthly payments.