UK inflation rose to 3.8% in July, driven mostly by transport costs and a surge in air fares. Hospitality and food also made large upward contributions because of rising labour costs following last October's Budget. UK inflation has diverged from the euro area, where inflation is around 2%, because of higher government-set prices (domestic energy bills and the national minimum wage), pass-through of higher employer taxes, and high housing costs as demand outpaces supply. Large food-price increases will drop out of annual comparisons, the labour market is cooling, and money growth is relatively subdued, supporting a path back to 2% by 2026, although inflation may worsen before improving.
The latest jump in UK inflation to 3.8% in July was not a big surprise - the Bank of England was already expecting an increase to 4% in September. But rising inflation will continue to eat into real incomes and keep bond yields high, adding to the government's cost of borrowing. The biggest contribution to the jump in inflation last month came from transport costs, mainly due to a surge in air fares which can be volatile at this time of year.
The bigger picture is that UK inflation has continued to diverge from the euro area, where inflation has settled at around 2%. This divergence is being driven by higher government-set prices (such as domestic energy bills and the national minimum wage), the continued pass through of higher employer taxes, and high housing costs as demand outpaces supply. There are still good reasons to expect inflation to start falling in October and drop back to the 2% target in 2026,
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