UK August CPI rises to 3.1%, a 5-month high; surging oil prices reinforce rate hike expectations.

UK inflation rose for a second consecutive month. Data published by the Office for National Statistics on Wednesday showed that the consumer prices index (CPI) rose 3.1 per cent in the year to August, the highest since March, up from 2.9 per cent the previous month and in line with the median forecast of economists but above the Bank of Englands previous forecast of 2.8 per cent. The acceleration in inflation was driven mainly by higher motor fuel prices. Affected by the ongoing war with Iran, prices at UK petrol stations rose markedly, with motor fuel prices up 6.9 per cent year on year in August, far above the 0.4 per cent increase in the same period last year; air fares, a volatile component, also rose 6.2 per cent month on month, above the 2.1 per cent increase a year earlier. Services inflation, a gauge of domestic price pressures, held at 3.4 per cent, while core inflation, which strips out energy, food, alcohol and tobacco, also held at 2.6 per cent. Food inflation was broadly unchanged at 1.1 per cent. Sterling was little changed after the data. Traders trimmed their bets on BoE rate hikes but still expect four increases over the next 12 months. The BoE will announce its rate decision this week, with the market widely expecting it to keep rates unchanged. However, as energy prices continue to rise, the central banks previous wait-and-see stance is coming under increasing pressure. BoE Governor Andrew Bailey also recently warned that new inflation risks are emerging, especially in food prices. The UK is experiencing an extreme drought, while the potential effects of El Nio could also push food costs higher. UK motorists are now facing the most expensive petrol and diesel prices since 2022, while international oil prices have risen above $100 a barrel. Higher energy prices not only directly push up current inflation but may also feed through further via household energy bills. Analysis by Bloomberg Economics shows that when the UK energy price cap resets in January next year, household energy bills could rise by about 25 per cent. If that increase materialises, CPI inflation could exceed 4 per cent in 2027, further increasing pressure on the UK government to support households. The BoE currently expects inflation to peak at 3.2 per cent in the fourth quarter of this year, still well above its 2 per cent target. However, domestic price pressures in the UK have not yet spiralled fully out of control. A BoE survey showed that households inflation expectations for the next year had fallen from 4 per cent in May to 3.2 per cent in August; another survey of businesses showed that companies expected wage growth in 2027 to be broadly in line with or below 2026, when average growth was 3.6 per cent. Bloomberg Economics believes higher energy prices could push UK CPI to slightly above 4 per cent early next year, and expects the BoE to keep rates unchanged at its September meeting but signal a hawkish stance, opening the door to tighter monetary policy later this year. Meanwhile, the UK economy has shown some resilience since the war broke out. The UK economy unexpectedly grew 0.4 per cent in July, but the energy price shock, a weak labour market and the risk of higher food prices in the future still leave the BoE facing a policy trade-off between controlling inflation and avoiding further drag on the economy.