Cost-of-living pressures remain stubborn as the UK economy shows fresh signs of contraction

UK inflation climbed to 3.6% in June, exceeding expectations and intensifying the monetary dilemma facing the Bank of England. The unexpected rise, reported by the Office for National Statistics (ONS) on Wednesday, reflects persistent price pressures amid a slowing economy—raising key questions about the next policy move in August.

While inflation has cooled significantly from its 2023 highs, the June reading was above the 3.4% forecast, marking another month in which price stability remains elusive. Combined with recent GDP figures showing a second consecutive monthly contraction in May, the central bank faces a difficult balancing act between fighting inflation and supporting growth.

Quantitative Review: Headline and Core Inflation Beat Expectations

According to the ONS, the Consumer Price Index (CPI) rose 3.6% year-over-year in June, up from 3.4% in May. Economists polled by Reuters had expected no change from the previous month’s figure.

Core inflation—which strips out volatile food, energy, alcohol, and tobacco prices—also rose to 3.7%, up from 3.5% in May. These figures highlight continued underlying price momentum and distance the current rate from the Bank of England’s 2% target.

In response, the British pound edged higher by 0.2% against the U.S. dollar, trading at $1.3406. This suggests that markets see the inflation data as likely to slow the pace of monetary easing, despite recessionary signals.

Drivers of Inflation: Fuel and Food Costs Lead the Climb

Richard Heys, Acting Chief Economist at the ONS, attributed the rise in June inflation mainly to modest fuel price decreases—especially when compared with the much steeper drops seen in the same period last year. This base effect contributed to a net increase in the year-on-year rate.

Additionally, food inflation climbed for the third consecutive month, reaching its highest annual pace since February 2024. Although far below the peaks seen in early 2023, rising grocery costs continue to weigh heavily on household budgets.

Chancellor of the Exchequer Rachel Reeves responded to the data by acknowledging the ongoing challenges for working families. “People are still struggling with the cost of living,” she said, adding that the government has more work to do to ease pressures on consumers.

Rate Path Dilemma: Navigating Between Inflation and Weak Growth

The inflation figures will be under close scrutiny ahead of the Bank of England’s next Monetary Policy Committee (MPC) meeting in August. Traditionally, central banks maintain higher interest rates when inflation is elevated, aiming to curb demand and slow price increases.

However, the UK’s weak economic backdrop complicates this approach. GDP unexpectedly contracted in May for the second consecutive month, raising concerns that the economy is on the brink of a technical recession.

In such a climate, cutting interest rates could help revive business activity and household spending—but loosening policy too soon risks rekindling inflation. The MPC must now weigh both risks in making its August decision.

Market Outlook: A 25 Basis Point Rate Cut Still Expected

Despite the inflation surprise, most analysts expect the Bank of England to proceed with a modest 25 basis point rate cut in August, marking the beginning of a gradual loosening cycle.

Adam Deese, an economist at PwC, noted: “While price growth remains above target, the back-to-back monthly contractions in GDP suggest that the Bank will look through some of this inflation volatility and proceed with a rate cut.”

He also emphasized that upcoming wage data—due out tomorrow—will be a key variable. If wage growth shows signs of cooling, the Bank may feel more confident in reducing rates without reigniting inflationary momentum.

Contrasting Trends: Rising Inflation, Falling Output

The UK’s economic picture underscores a difficult paradox. On one hand, structural inflationary pressures remain due to tight labor markets, elevated input costs, and lingering supply chain inefficiencies. On the other hand, weak consumer demand, declining business profitability, and subdued investment point to a deteriorating growth outlook.

Managing this divergence—cooling inflation without deepening the slowdown—is the central challenge for UK policymakers in 2025. Britain’s economic fragility, exacerbated by post-Brexit trade frictions and a struggling housing sector, adds another layer of complexity.

Global Comparison: The UK Sits Between the US and Eurozone

Compared to the U.S., where inflation has eased to around 3.0% and growth remains relatively resilient, the UK economy appears more fragile.

In contrast, the Eurozone reported an annual inflation rate of about 2.5% in June—lower than the UK—but faces its own sluggish growth. Britain thus finds itself between two major economies: inflation is more elevated than in Europe, yet growth is weaker than in the U.S., exposing it to a unique dual risk.

Conclusion: Mixed Signals, Difficult Decisions Ahead

The rise in UK inflation to 3.6% in June highlights the ongoing complexity of the current macroeconomic landscape. Cost-of-living pressures persist, even as economic activity slows and recessionary risks mount.

The Bank of England must now decide whether to begin cutting interest rates despite stubborn inflation, or maintain tight policy at the risk of deepening the slowdown.

Much will depend on incoming wage data and broader economic signals—but one thing is clear: the path ahead for monetary policy is narrower than ever.