U.K. inflation jumped in July, driven by an anticipated surge in household energy costs, and a resurgence in global energy prices could push prices even further above the Bank of England's target in the months to come.
Consumer prices rose 2.9% in July from a year earlier, up from 2.6% in June, the Office for National Statistics said Wednesday. That is the highest annual inflation rate since March, when prices spiked following the outbreak of the war in Iran.
The reading matched the consensus forecast of economists polled by The Wall Street Journal.
The acceleration was driven largely by household energy prices, with electricity regulator Ofgem lifting the energy price cap for households by 13% at the start of July.
Simmering tensions in the Middle East also kept oil prices elevated throughout the month. While global energy prices fell in early July on hopes for a ceasefire, they picked up again later in the month amid heightened tensions. Brent crude is currently trading above $91 a barrel.
"Looking ahead, energy inflation should rise further at the next print given recent increases in petrol and diesel prices, pushing headline inflation further above the [Bank of England's] forecast," Goldman Sachs analysts said in a note.
Rising inflation is a thorn in the side of new Prime Minister Andy Burnham, who has made the cost of living a centerpiece of his policy agenda. Among his first moves in charge has been to cushion the blow of higher prices, cutting value-added tax on energy bills starting in October and capping bus fares.
For the Bank of England, the prospect of further inflationary pressures has strengthened the case for raising interest rates this year. Core inflation, which excludes energy, food, alcohol and tobacco, was unchanged in July--slightly hotter than expected--suggesting that higher energy costs are maintaining pressure on broader price trends.
"If inflation continues to surprise on the upside--and it could get closer to 4%--the Bank of England will be forced to raise interest rates. More restrictive monetary policy would not be beneficial to an economy that is already expected to slow down later this year," said Joe Nellis, head of economic research at MHA.
The central bank is expected to leave its benchmark interest rate unchanged at 3.75% at its next meeting in September, after holding rates in July by a 6-3 vote. Three policymakers voted for an increase at that meeting.
The case for keeping rates on hold is being bolstered by limited evidence of second-round inflationary effects from higher energy prices. Despite stronger-than-expected core inflation, there are still few signs that businesses are passing costs on to customers, with food and services inflation declining.
That comes alongside signs that wage pressures are cooling. Private-sector earnings growth edged down to 2.8% from 2.9% in the three months through June, according to data published on Tuesday.
Still, stronger-than-expected economic growth is adding to the case for higher rates. The economy expanded 0.4% in the second quarter, or 1.7% on an annualized basis, outperforming several other major economies including the U.S. BOE Chief Economist Huw Pill said stronger growth supports the case for raising rates to contain inflation.
Markets continue to expect at least one rate increase by the end of the year, even as some economists argue the central bank could look through the energy-driven rise in headline inflation.
"Though headline inflation is likely to rise towards 3.5% later this year, we see little reason for the Bank of England to hike rates through 2026," ING analysts said, adding that they expect rate cuts to resume in 2027.
Before the Middle East conflict erupted, the BOE had expected inflation to fall below its 2% target this year, while investors had priced in several rate cuts. But continued uncertainty in the Strait of Hormuz means policymakers are likely to remain on high alert, with the prospect of higher energy prices increasing the risk of a downturn in the economy as well as upside pressures on inflation.