UK inflation falls to 2%. A temporary dip or a longer-term trend?

Prices across the UK rose by 2% in the year to July, according to the latest figures from the Office for National Statistics (ONS), falling short of expectations. CPI was unchanged in July, compared with rises of 0.4% in July 2020.

Why has inflation dipped?

The lower reading was caused by a fall in prices in clothing and footwear, said the ONS, as retailers cut prices and offered summer sales. But this was partially offset by a rise in the price of second-hand cars, which fell last year: “Inflation fell back in July across a broad range of goods and services, including clothing... This was offset by a sharp rise in the price of second-hand cars,” says Jonathan Athow, ONS’ deputy national statistician.

Wednesday’s reading came after UK inflation had jumped to its highest level in three years last month with CPI hitting 2.5% thanks to an increase in the price of food, dining out, and clothing and footwear. So the dip is also related to the fact that price rises were exceptionally high last month.

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Britain’s FTSE 100 stockmarket index fell 0.4% on the news, while the pound was 0.2% higher against the dollar at $1.376.

Is this a short-term dip?

Markets have been divided as to whether inflation, which has been rising across several major economies, is transitory or whether it should be a reason to worry and result in an earlier tightening of monetary policy.

“This is good news for those fretting about rising prices but potentially raises some questions about the strength of the UK economic recovery,” says Russ Mould, investment director at AJ Bell.

But Ian Warwick, managing partner at Deepbridge Capital, is less convinced that Wednesday’s lower than expected reading means inflation has cooled off: “While inflation may have slowed slightly to fall within the Bank of England’s target of 2% this does not mean that rates won’t pick up over the coming months,” he said.

Many early-stage businesses will be thriving in the recently reopened economy, but they will keep an eye out for any rise in interest rates as it could limit the amount they can borrow at a pivotal time, he adds.

This view is echoed by other experts: “Inflation stepped off the accelerator in July, but this doesn’t mean we’re set for a gentle ride, because it owes an enormous amount to an artificial bump in prices a year earlier. The underlying pressure on prices, particularly from soaring petrol and second-hand car prices, mean it’s set to pick up speed again soon, and may well hit 4% by the end of the year,” warns Sarah Coles, personal finance analyst at Hargreaves Lansdown.