The Bank of England is bracing for a setback in its battle against high inflation this week amid expectations of a first central rate rise this year, highlighting the pressure from the cost of living crisis.
In a week of key updates on the British economy, official figures on Wednesday are expected to show inflation was back above the Bank’s 2% target in July, driven in part by rapidly rising prices for airfares, package holidays and hotels.
City economists said headline inflation was on track to rise 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 drop in household energy prices in July compared with the same month last year, when prices fell sharply, meaning the year-on-year inflation rate is set to rise.
Analysts said that while inflation in services prices was slowing, price growth in this dominant sector of the British economy was on track to stay above 5%, driven by airfares, package holidays and hotel prices.
This 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 implement dynamic pricing to respond to increased demand, including around UK tour dates for stars including Taylor Swift and Pink.
Rob Wooden, chief UK economist at consultancy Pantheon Macroeconomics, said: “The ONS only looks at around 100 hotels, meaning outliers, such as a price increase at a Welsh resort in June due to demand for a Pink concert, can distort the figures. But some hotel price inflation is genuine.”
The rise in overall 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 retreated sharply from a peak of 11.1% in October 2022 after Russia’s invasion of Ukraine triggered an explosion in energy prices.
Threadneedle Avenue has warned that inflation is likely to rise to around 2.75% in the second half of this year, driven by rising service sector prices and a resilient UK labour market. However, it expects these inflationary pressures to gradually fade, bringing headline inflation back to 1.7% in two years, before falling to 1.5% in 2027.
The Bank is widely expected to cut its base rate to around 3.5% before the end of 2025. However, Andrew Bailey, the Bank’s governor, has said it will need to be careful not to cut borrowing costs too quickly or too much, amid concerns about persistent inflationary pressures.
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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 Metropolis analysts estimating second-quarter growth of 0.7%, the same pace as the first quarter.
However, Tuesday’s labor market figures are expected to show a cooling of the job market, with rising unemployment and slowing wage growth forecast by Metropolis analysts.
A separate report from the Chartered Institute of Personnel and Growth on Monday shows that UK employers expect pay growth over the next 12 months to fall to 3%, down from a previous estimate of 4% made in the first quarter of 2024.
James Cockett, senior labour market economist at the CIPD, said: “Falls in expected pay rises were expected now that inflation is within a tolerable range for employees. However, many workers will still feel worse off than they did a couple of years ago.”
