Although UK inflation has fallen to its lowest level for 15 months, the outlook for borrowing costs remains far from clear as a result of rising energy prices, renewed tensions in the Middle East and the arrival of a new Prime Minister.
Inflation fell from 2.8% in May to 2.6% in June, bringing it closer to the Bank of England’s 2% target. The UK’s inflation rate is now below the European Union average, although it remains slightly above Germany’s 2.4% and France’s 2.0%.
Lower transport costs were one of the main reasons for the decline. Petrol prices fell by 2.1p a litre during the month, while diesel dropped by 10.7p. Food inflation eased from 2.2% to 1.7%, its lowest level since August 2024.
Clothing prices also helped push inflation lower. Retailers offered larger discounts during the summer sales than they did a year earlier, contributing to a fall in the cost of clothing and footwear.
In addition, the ONS reported raw material prices fell for the first time since January, largely because oil prices were lower during the period covered by the data.
Data already dated
Under normal circumstances, those figures would strengthen the case for the Bank of England to leave the base rate unchanged at 3.75% when policymakers next meet.
The inflationary picture, however, is less straightforward than it appears.
Much of June’s improvement was driven by lower fuel costs. Since then, Brent crude oil has climbed back above $90 a barrel following renewed military action with Iran, reversing much of the decline that helped pull inflation lower during June.
The latest inflation data also predates July’s increase in the energy price cap. Household energy bills rose by 13% this month, creating additional inflationary pressure that has yet to be factored into the official figures.
It means June’s inflation figure may say more about what was happening last month than what is likely to happen during the second half of the year.
What does that mean for mortgage rates?
Mortgage costs are not just influenced by the Bank of England’s base rate, but also by expectations for future inflation and interest rate movements (swap rates).
It has meant several lenders have increased selected mortgage rates this month despite the fall in inflation.
And that uncertain outlook for borrowing costs is not solely the result of inflation but also the change at Number 10 Downing Street.
In his first speech as PM, Andy Burnham outlined ambitious plans for house building, infrastructure and measures aimed at reducing living costs. What he didn’t say, though, was how those commitments will be funded and what impact they may have on government borrowing.
Financial markets have already shown signs of nervousness, and UK borrowing costs rose following his comments about using greater “flexibility” within the fiscal rules.
Investors watching government spending plans
James Athey of fund management group Marlborough warned that investors would be watching closely for any indication that the government intended to increase borrowing.
And the Institute for Fiscal Studies has pointed out that the underlying fiscal constraints facing the government remain unchanged, with debt, borrowing and debt interest costs already at historically elevated levels.
The Autumn Budget should bring some clarification over the government’s spending plans, how they will be funded and whether markets believe they can be delivered without adding further inflationary pressure.
Period of hiatus
In the meantime, there will be a hiatus period, with much depending on how Burnham handles the run-up to the Budget. Rachel Reeves often kept her cards close to her chest beforehand, creating months of fevered speculation that many blamed for damaging confidence and unsettling markets.
When that is added to the concerns over inflation, it has resulted in a more volatile mortgage market. Earlier in the summer, the improving outlook encouraged lenders to cut rates and compete more aggressively for business. Lenders, though, are now becoming more cautious, with some already increasing selected mortgage products.
The movements remain relatively small – tenths of a percentage point rather than whole percentage points – and there are unlikely to be any major changes until the outlook becomes clearer.
Mortgage brokers, though, are still reporting that many borrowers whose current deals are due to expire within the next six months are choosing to lock in rates now to protect themselves against any future rises.
