The Office for National Statistics reported on Wednesday that the UK's annual CPI inflation rate climbed to 2.9% in July, up from June's 15-month low of 2.6% and marking the highest reading since March. Including housing costs, the CPIH measure rose to 3.1%. On a monthly basis, both metrics increased by 0.3%.
While the Bank of England had projected in late July that inflation would only tick up to 2.8%, the actual figure came in slightly hotter, though it aligned with the median estimate from Bloomberg economists. The dominant driver behind the acceleration was highly concentrated: Ofgem's roughly 13% increase to the energy price cap that took effect in July. Natural gas prices surged 14.7% year-on-year, a stark reversal from the 7.2% decline recorded in the same period last year. The typical dual-fuel direct debit bill now stands at approximately £1,862, representing an increase of £221 from the previous cap level. Gas prices reached their highest point since March 2024, with the monthly rise being the sharpest since October 2022.
Looking at the breakdown, energy pushed inflation upward while services and food provided some offsetting relief. Housing and household services made the largest upward contribution, followed by furniture and household goods. Transport provided the biggest downward offset, with diesel prices falling 8.8 pence per litre and petrol down 3.1 pence, while European flight tickets turned to year-on-year declines. Food and non-alcoholic beverage inflation eased from 1.7% to 1.3%, with its contribution to CPIH falling to its smallest since October 2021.
Core CPI, which strips out energy, food, alcohol, and tobacco, held steady at 2.6%. The core CPIH measure edged up to 2.9%, marking its first increase since February. Goods inflation rose from 1.7% to 2.2%, while services inflation moderated from 3.6% to 3.4%. Given the Bank's particular focus on services and wage growth, the cooling in services inflation represents the relatively friendlier aspect of this report.
Ofgem had already announced in May that the third-quarter cap would rise by 13%. The assessment window for this decision ran from February 18 to May 18, a period that conveniently captured the first wave of wholesale gas price increases following the outbreak of the Middle East conflict. Electricity prices rose less than gas, with increases of approximately 5% and 24% respectively, reflecting the growing share of renewable generation. Around 40% of household accounts remain on fixed tariffs and are not directly affected by this increase. Even so, the standard variable tariff alone has been sufficient to lift the annual CPI rate by 0.3 percentage points.
The Bank of England had already factored this rebound into its policy path, yet it remains wary of second-round effects. The Monetary Policy Committee voted 6-3 to hold the bank rate at 3.75% on July 29. The accompanying statement was blunt: CPI has fallen from its earlier peak to 2.6%, but energy prices will continue to transmit through the economy in the second half of the year. The longer energy price rises persist, the greater the risk of second-round effects on prices and wages. The July Monetary Policy Report's central projection sees inflation rising to around 3.2% by October and remaining above 3% through the third quarter of 2027. That forecast was based on mid-July energy prices. If the Strait of Hormuz standoff keeps Brent crude above $90 per barrel, there remains scope for another upward adjustment to the cap in October.
The government plans to scrap the 5% VAT on household electricity bills from October, which the Bank estimates could reduce the fourth-quarter cap by approximately £45. This represents a policy offset rather than a cooling in demand. The labour market constitutes the other half of the constraint. The committee emphasised that underlying price and wage pressures are easing and that the labour market remains soft, which is why the majority chose to hold rates in July. Today's data validates the decomposition of "a one-off energy spike with underlying inflation still moderating": core inflation has not accelerated, and services are slowing. The question now is whether the one-off effect becomes persistent - if wholesale gas prices fail to retreat, household bills will re-enter the CPI calculation this winter.
For gilts, sterling, and fiscal policy, the data largely met expectations, and immediate market reactions in sterling and gilt futures were limited. The real pricing has already occurred at the long end of the curve: the UK 30-year gilt yield has risen to around 5.8% this week, with the 10-year yield hovering near 5.1%, as global fiscal premia and energy inflation converge. For the Bank of England, the 2.9% reading alone does not constitute an immediate case for rate hikes, but it narrows the room for "waiting one more round of data." If core and services inflation resurge in September or November, the consensus for holding at 3.75% would fracture, much like the three dissenting votes already seen in July.
The fiscal side is more awkward. The Burnham government has made the cost of living a central pillar, yet the October VAT reduction on electricity bills offsets only about £45 against the £221 increase already applied to bills in July. The energy cap adjusts quarterly, and wholesale markets are watching the Strait of Hormuz rather than Downing Street. Every additional month that inflation lingers near 3% erodes fiscal headroom through nominal spending and debt servicing costs. Parliamentary Library analyses have also highlighted that the spillover from the Middle East conflict into energy prices is the primary external factor keeping UK inflation from returning to the 2% target.
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