Inflation will ease over summer, but significant risks remain

Inflation slowed in June as lower oil prices fed through to retail prices. Fuel prices will continue to ease through July as the extension to the emergency fuel excise duty cuts and lower wholesale prices weigh on inflation. However, inflation will remain elevated until the Spring as utility bills begin to rise and indirect effects from higher airfares, food and core goods inflation add to inflationary pressures.

Lower oil prices help to weigh on inflation in June

Inflation eased from 3.6% to 3.4% in June as falling oil prices dragged down motor fuel and heating oil inflation. Even with the rebound in oil prices from $70 to $77per barrel this week, prices are still well below pre-peace accord levels, which should continue to weigh on forecourt prices through July.

That said, the conflict in the Middle East continues to put upwards pressure on inflation as electricity inflation rose from 3.3% to 4.2% and gas inflation turned positive as firms respond to higher wholesale gas prices by hiking energy bills. Indeed, wholesale gas prices take much longer to filter through to household bills than oil does. We think utility bills inflation will continue to rise throughout the rest of this year and into next year.

Food inflation eased from 1.3% to 0.6% as wholesale food prices were falling in the final months of last year which has helped to weigh on supermarket prices, but this will reverse as higher energy and fertiliser prices make their way through supply chains even if its by less than previously feared.

Elsewhere, airfares inflation dropped from 14.1% to 4.6% but should rebound as we enter the summer months and airlines begin to pass on increased fuel costs to passengers.

All told, lower oil prices helped to weigh on inflation in June and the extension of emergency fuel excise duty cuts means inflation is likely to continue to ease through the summer.

Three reasons for sticky price pressures until next year

We think inflation will remain between 3-3.5% until Spring 2027 for three reasons.

Energy prices - while oil prices have fallen back sharply, natural gas prices remain 57% above pre-war levels. That means utility providers will hike bills throughout the second half of this year and into 2027, keeping energy inflation sticky even as pump prices fall back.
Supply-chains - the impact of higher energy prices is still working its way through supply chains which will push up core goods inflation at the end of this year. Similarly, we expect airfares to rebound sharply from their weak June print in the coming months as firms pass on higher jet fuel costs to passengers and food inflation rebounds due to the jump in fertiliser and energy prices.
Services inflation - services inflation held at 4.0% in June and is likely to rise a little further in the immediate-term before easing. The ECB’s June rate hike will push up mortgage interest inflation and the Governing Council may opt to hike again in September despite the drop in oil prices. What’s more, we doubt there will be much relief for consumers from the VAT cut on hospitality given the margin pressure in the sector from recent hikes to the minimum wage, the introduction of auto-enrolment pensions and rising input costs.

Putting it all together, this means that even with the sharp drop in oil prices inflation is likely to remain around 3-3.5% until March when favourable base effects will push inflation back towards 2%.

That said, we continue to think the risks to inflation are skewed to the upside, reescalation in the Middle East has already prompted oil prices to rebound off the back of new US strikes. Further signs of disruption to energy markets could push oil and gas prices even higher which would put more upwards pressure on inflation.