UK Inflation Erupts to 3.1% as Energy Shock Punishes Consumers

The U.K.’s annual inflation rate jumped to 3.1% in August as surging gasoline and diesel prices intensified pressure on households. The reading matched economists’ expectations and marked the first time inflation had exceeded 3% since March.

The Office for National Statistics said rising motor fuel costs were the main force behind the increase. Those costs surged 23% year on year, reflecting a sharp escalation in the prices motorists paid at the pump.

Average gasoline prices rose by 9.1 pence, or $0.12, per liter between July and August. That increase pushed average gasoline prices to their highest level since Nov. 2022, while average diesel prices climbed by 14.2 pence per liter during August.

Crude oil prices have remained above $100 a barrel, adding to the energy cost pressure. Earlier this week, British motoring organization the RAC said gasoline and diesel had reached prices not seen in four years since the Iran war began.

The latest acceleration followed a rise in annual inflation to 2.9% in July. That increase came as a government regulated price cap on energy costs was revised sharply upward, exposing consumers to another round of higher household expenses.

Electricity, gas and other household fuel costs increased 6% year on year in August, according to the ONS. The U.K., which is a net importer of energy, is particularly vulnerable to external shocks affecting energy supply and prices.

The country is still contending with a cost of living crisis that followed post pandemic inflation and surging energy costs after Russia’s full scale invasion of Ukraine in 2022. August’s figures showed how fuel and household energy remain central to that burden.

U.K. government bond yields fell across the curve after Wednesday’s inflation release. The yield on the 30 year gilt, which reached a 28 year high on Tuesday, was almost 2 basis points lower at 5.907%.

The benchmark 10 year gilt yield was nearly 3 basis points lower at 5.365%. The British pound was flat against both the U.S. dollar and the euro following the release of the inflation data.

Attention now turns to the Bank of England’s Monetary Policy Committee, which is scheduled to announce its latest policy update on Thursday. LSEG data showed markets pricing in more than an 80% chance that the central bank would keep its key interest rate at 3.75%.

Markets nevertheless anticipate an interest rate increase at the Bank of England’s next meeting in November. Rising costs also add pressure on new Prime Minister Andy Burnham, who has pledged to address the cost of living burden while balancing public finances and placating the bond market.

James Smith, developed markets economist at ING, said there was “nothing in the latest UK inflation numbers that screams a need to hike interest rates.” He said there was very little evidence that the energy shock was spreading into other portions of the inflation basket.

Smith pointed to food and non alcoholic beverage inflation, which eased to 1.1% year on year in August. He also said inflation among goods and services previously classified by the ONS as having high or very high energy intensity had fallen this year, with no sign of a reversal in August.

Bogdan Toma, a partner at McKinsey & Company, said gasoline prices near a four year high could signal uncertainty for the important final quarter. Households are absorbing back to school costs while facing the possibility of higher interest rates, potentially leaving fourth quarter demand subdued.

Toma said the final quarter is critical to annual profitability for many non food retailers and some grocery businesses. He warned that competition for fewer and smaller shopping baskets could become especially intense, putting more pressure on retailer margins that are already challenged.

Scott Gardner, an investment strategist at J.P. Morgan Personal Investing, said the inflation increase was unlikely to persuade the Bank of England to raise rates immediately. However, he said it could renew concerns among policymakers about the inflation outlook.

Gardner said higher energy costs were still filtering into business input prices and household spending more than six months after the conflict between the U.S. and Iran began. He added that industry surveys indicated renewed cost pressure in manufacturing and services, while private sector wage growth remained muted and the labor market stayed soft.

His team is monitoring potential second and third round effects from higher costs across the economy. Gardner said food prices had begun edging upward after fertilizer costs increased earlier this year, while additional pressure could emerge if businesses pass their own higher costs to customers.

Gardner also identified artificial intelligence demand for metals, semiconductors and other supply chain goods as an overlooked part of the inflation picture. He said it remained too early to determine whether the energy price spike was becoming a broader inflation shock, with much depending on the duration of the Middle East war.