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Andy Burnham’s vows to lead a “cost of living” government received a boost on his third day in office as inflation data for June undershot City forecasts.
Coupled with sluggish wage growth and a weak labour market, the drop in inflation to 2.6 per cent should reduce the need for the Bank of England to increase interest rates from 3.75 per cent, despite high energy costs, alleviating some pressure on UK government bonds, said investors.
“The Burnham government could get a bit lucky,” said Benjamin Jones, global head of research at Invesco.
He pointed to factors such as soft services inflation and slower wage growth, arguing the next move by the BoE could be a rate cut rather than an increase. “I’m on the cautiously optimistic side.”
Nevertheless, the broader economic backdrop facing Burnham and his new chancellor, John Healey, remains unforgiving. Renewed gains in European gas prices on Wednesday are likely to propel inflation higher later in the year, meaning more people will see their pay shrink in real terms.
“Higher inflation is still coming,” said Paul Dales at Capital Economics. Price growth will peak at 3.5 per cent early next year, he predicts, warning that the latest rebound in energy prices will strengthen this impulse.
Burnham’s early economic interventions have been reassuringly inexpensive, analysts said, coupling the elimination of VAT on electricity bills with a cap on bus fares. But bond markets remain on edge given the scale of the UK’s fiscal challenges alongside weak growth prospects.
Government insiders insist the new Labour leadership realise the importance of establishing credibility on inflation and fiscal policy, pointing to Burnham’s insistence that early interventions are paid for via savings elsewhere. “They get it on that front,” said one.
The focus on the cost of living measures is meant to tackle core concerns among voters after five years in which inflation has run above the BoE’s 2 per cent target.
Wednesday’s surprisingly benign CPI data showed UK inflation below Eurozone inflation rate for a third straight month.
Food price inflation subsided to 1.7 per cent in June, down sharply from 4.5 per cent the same month a year earlier and the lowest since the summer of 2024. This came as a relief to economists who had worried that rising energy prices would quickly spread into other parts of the economy.
“For those BoE officials who worry about the ‘salience’ of food and petrol prices in forming consumer inflation expectations, the latest fall in both should be welcomed,” said James Smith, UK economist at ING.
He argued the BoE is more likely to raise interest rates if inflation is projected to reach 4 per cent — something he sees as unlikely. “We’re still some way below getting there, even with the latest rise in oil and particularly natural gas prices.”
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The bigger worry for the MPC’s hawks has been that high wage growth could both push up companies’ costs and allow them to charge higher prices, in a self-perpetuating cycle. This prospect is also receding, at least for now.
Data released this week showed annual growth in private-sector wages, excluding bonuses, dropped below 3 per cent for the first time in five years in the three months to May.
With hiring weak and employment flat, workers appear to be in a worse position to bargain for higher pay.
“As the inflationary effects of past policy mistakes fade, slowing wage inflation due to a deteriorating labour market will become obvious,” said Andrew Wishart, economist at Berenberg.
Public sector pay is still growing at a faster pace, up 5.5 per cent from a year earlier — a factor that economists say may account for the recent resilience of consumer spending.
But the BoE views private sector pay as a better measure of inflationary pressure, given it feeds directly into consumer prices. Given separate evidence of a pick-up in productivity growth, the bank is likely to see 3 per cent pay growth as compatible with its inflation target.
This should give BoE rate setters more confidence to “look through” the temporary effects of the energy shock when they meet next week, provided there is no big flare-up in the US-Iran conflict, economists say.
“For most businesses, energy costs are a much smaller share of total operating costs than wages. So a longer and more material overshoot from an external shock can only really come via the labour market,” noted Bruna Skarica, chief UK economist at Morgan Stanley, adding: “For now, there is no evidence of an inflection in pay pressures happening in the UK.”
Despite the relief in the City at this week’s data, investors stressed the deeper challenges facing the Labour government remain formidable.
Market reaction to the initial days of Burnham’s tenure has been “relatively sanguine,” said Jones of Invesco, despite wider concerns about the Iran conflict and energy prices.
But he said investors are in “wait-and-see mode” given fiscal challenges such as the need to fund rising defence requirements.
The threat of rising energy costs will hang heavily over next week’s BoE’s rate-setting meeting, at which the bank is expected to keep its key rate unchanged. Burnham’s early cost-of-living interventions are expected to have only a marginal impact.
“This is the third time in a row that inflation surprised to the downside — but it is unlikely to last,” said Tomasz Wieladek, an economist at T Rowe Price.
