UK inflation dropped unexpectedly to 2% in July, but economists think it won’t be long until it shoots up again

• UK inflation unexpectedly fell to 2% in July, the Office for National Statistics said Wednesday.
• Economists said the dip is likely temporary and prices should rise sharply by the end of the year.
• The Bank of England has said it is likely to have to tighten monetary policy to keep a lid on inflation.
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Prices across the UK economy rose 2% in the year to July, the Office for National Statistics said Wednesday – a lower than analysts were expecting and a slowdown from inflation of 2.5% in the year to June.

Economists said the slowdown in consumer price index, or CPI, inflation was likely a blip. They said prices should start rising sharply again over the coming months, as the economy rebounds after the government eased coronavirus restrictions.

The ONS said the unexpectedly strong slowdown was in part due to “base effects”, given that inflation rose sharply in July 2020, the month that the latest figure is measured against. Economists said base effects should help drive up inflation readings before the end of the year.

“July’s data is likely to represent brief respite from the upward movement in inflation rates,” said Martin Beck, senior economic advisor to the EY Item Club.

“August will see base effects push annual inflation up again, with last August having seen both the [value-added tax] cut for the hospitality sector and the eat out to help out [meal subsidy] scheme.”

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The ONS said lower clothing and footwear prices weighed on July’s inflation reading, as retailers brought back summer sales after scrapping them during the pandemic. But this was offset by a sharp rise in the price of second-hand cars, due to a shortage of new models.

Britain’s FTSE 100 stock index was down 0.36% after the data was released, while the pound was up 0.13% against the dollar at $1.376.

The Bank of England said earlier this month that it expects inflation to rise to 4% towards the end of the year. Britain’s central bank said “some modest tightening of monetary policy is likely to be necessary” over the next two years to keep price rises in check.

Ruth Gregory, senior UK economist at Capital Economics, said: “Despite July’s fall, we still expect inflation to reach about 4.5% by November.”

She added: “So the coming months won’t be comfortable for the [Bank of England’s] Monetary Policy Committee. But provided inflation expectations and underlying pay growth do not rise significantly, we think that inflation will fall back to just 1.5% by the end of 2022.”

Gregory said this means the Bank will be able to look through the upcoming spike in inflation and keep interest rates at their current, record-low levels of 0.1% until mid-2023.