Economic update: Inflation continues to fall as earnings growth rises

Despite a larger than expected fall in inflation in June 2023, continued high growth in prices and earnings are expected to mean a further rise in interest rates at the beginning of August.

This Insight covers the growth in prices and earnings, and how these might affect interest rates, as well as the latest national debt statistics.

Inflation fell by more than expected in June 2023…

The annual inflation rate in the UK dropped to 7.9% in June 2023 according to the Office for National Statistics (ONS), which is the lowest it has been since March 2022. It was 8.7% in May.

The annual inflation rate is defined as the change in average prices compared with those in the same month the year before. It reached a peak of 11.1% in October 2022.

A lower annual inflation rate does not mean that prices are falling, but that prices are going up less quickly.

Economists expected the inflation rate to remain above 8% in June, with those surveyed by Reuters forecasting a rate of 8.2%.

This fall was mainly driven by falling prices for motor fuel, which the insurance company RAC reported .

Further falls in the overall inflation rate are expected over the rest of 2023, which the Governor of the Bank of England said was largely due to falling energy prices (PDF),with economists forecasting that it will have fallen to 5.0% in the final quarter of 2023.

…while earnings growth reaches record high…

The year-on-year growth in cash terms for earnings excluding bonuses was 7.3% in March to May 2023, which was the joint highest growth rate since records began in 2001.

Recent high growth in earnings has been due partly to inflation and partly due to the UK’s tight labour market. Low unemployment rates and a high number of job vacancies have meant that most of those who want to work were in work, and recruitment has been harder.

Despite a loosening of the labour market in recent months – with making it easier for employers to recruit – there has been continued growth in earnings.

However, despite the high growth in nominal earnings, there was a continued fall in real-terms because of the high levels of inflation.

…which may lead to a further rise in interest rates

The Governor of the Bank of England has described the rate of price increases and earnings growth as “not consistent with the inflation target” (PDF) of 2%.

The Bank of England’s Monetary Policy Committee (MPC) will monitor developments in the labour market and in earnings growth to determine whether they are proving to be more persistent inflationary pressures.

The MPC has raised interest rates at 13 consecutive policy meetings with rates going up from an all-time low of 0.1% in December 2021 to 5.0% at the MPC’s meeting in June.

The continued high growth in earnings has led to economists forecasting a further rise in interest rates in August.

Although a 0.5 percentage point increase was initially forecast, the lower-than-expected inflation rate and concerns regarding the impact of interest rate rises on economic performance have led some economists to suggest a smaller 0.25 percentage point increase.

National debt rises to the equivalent of 100% of GDP

Government debt exceeded 100% of GDP at the end of June. Revisions to the previous month’s data mean that this is the first time debt has breached 100% of GDP since 1961. Debt was around 30% of GDP in the early 2000s. It has grown largely due to the 2007–2008 financial crisis, the Covid-19 pandemic and the recent energy crisis.

In a report released this month, the Office for Budget Responsibility said that reducing debt between crises has proven more difficult than in the previous century. Government debt has fallen in only three of the last 12 years, despite all UK Chancellors since 2010 committing to reducing government debt as a percentage of GDP.

Further reading

• House of Commons Library, Economic indicators
• House of Commons Library, The UK’s fiscal targets
• House of Commons Library, The budget deficit: a short guide

About the author: Andrew Powell is an economic researcher at the House of Commons Library.

Photo by Eduardo Soares on Unsplash