British household inflation expectations sharply drop, easing pressure on the Bank of England to raise interest rates.

The latest monthly survey released by Citibank and YouGov shows that as oil prices fall, inflation expectations for British households have significantly decreased in June. The inflation expectation for the next year dropped from 4.7% in May to 3.8% this month, falling back to the level before the outbreak of the Iran war in January. Long-term inflation expectations also decreased by 0.1 percentage points to 3.9%, remaining flat with the average level of the six months before the conflict. The announcement of this data provides the latest evidence that the risk of inflation expectation "unanchoring" is diminishing for the Bank of England, leading to a further reduction in the market's bet on an interest rate hike by the Bank of England this year. Sharp drop in inflation expectations: oil price decline as a key driver The sudden decline in inflation expectations is most directly driven by the decrease in energy prices. Since the ceasefire agreement between the US and Iran, allowing ships to start passing through the crucial Strait of Hormuz, international oil prices have significantly fallen. Boosted by the ceasefire news, international oil prices have dropped below $80 per barrel for the first time in three months, significantly lower from the previous high of $108 per barrel. As the UK heavily relies on energy imports, the drop in oil prices directly eases the pressure of input-type inflation. Bank of England Governor Bailey explicitly stated in the policy statement on June 18 that the recent fall in oil prices was "encouraging". Data from the UK's Office for National Statistics shows that the overall inflation rate in the UK has dropped to 2.8%, but still higher than the Bank of England's target of 2%. Institutions currently predict that the peak inflation rate will be lower than 3%, much lower than the best estimate in the Bank of England's forecast in April. Citibank: The risk of "unanchoring" is diminishing Citibank economist Callum McLaren-Stewart gave a clear interpretation of the survey results. He pointed out that an important aspect of the hawkish argument of the Bank of England is the risk of inflation expectations "unanchoring". "The results of this month's Citibank/YouGov survey are likely to have a negative impact on this," McLaren-Stewart said. "We believe that the risk of 'unanchoring' is diminishing." This assessment is in line with the cautious stance within the Bank of England. Although two members advocate for an immediate rate hike, the majority believes that weakened demand and loosening job market could alleviate the secondary transmission pressure of inflation to some extent. Data shows that since the outbreak of the Iran conflict in February, the UK has already lost about 64,000 jobs, with the regular wage growth rate in the private sector falling to a five-year low. Pressure for an interest rate hike by the Bank of England eases Internal divisions still exist within the Bank of England, key to inflation outlook The cooling of inflation expectations provided crucial support for the Bank of England's interest rate decision on June 18. On that day, the Monetary Policy Committee (MPC) of the Bank of England decided to keep the benchmark interest rate unchanged at 3.75% by a 7:2 vote, maintaining a "wait-and-see" stance for the fourth consecutive meeting. The two members opposing the vote were external member Megan Greene and Chief Economist Hugh Pyle, both advocating for an immediate 25 basis points rate hike to 4% to curb further upward inflation expectations. The members who advocated for a rate hike believed that it was necessary to tighten policy preemptively to control households' expectations of future inflation. Governor Bailey continued his stance of "positively maintaining the status quo", indicating that the current stance of holding steady has already been an effective form of tightening compared to the expectations of a rate cut path before the conflict outbreak in the Middle East. The majority of the committee believed that the tightening of financial conditions since the Middle East conflict began had provided a buffer against inflation. Regarding inflation forecasts, the Bank of England made adjustments in both directions. The Bank now expects CPI to rise to over 3.25% in the fourth quarter of this year, higher than the 2.8% forecast in May but lower than the high range of 3.6% to 3.7% in the April scenario analysis. Meanwhile, the potential GDP growth rate for the second quarter was revised up to 0.2%, an improvement from the 0.1% forecast in April. The minutes of the Monetary Policy Committee meeting showed that the members unanimously believed that if inflation continued to rise, "appropriate policy responses should be firm and strong." The committee reiterated that they were "prepared to take necessary actions at any time to ensure that CPI inflation returns to the target of 2% in the medium term." Market expectations reverse: from rate cuts to hikes and back to wait-and-see Market expectations for the Bank of England's policy path have undergone a dramatic reversal in recent months. Before the outbreak of the US-Iran conflict in February, the market generally expected the Bank of England to start a rate cutting cycle within the year; however, as the conflict drove up energy prices, market expectations quickly shifted to betting on rate hikes. Now, with the decline in inflation expectations, market expectations have adjusted once again. As of June 18, the market predicts only a 22 basis points rate hike by the end of the year, whereas during the peak tensions in US-Iran relations, the market had predicted rate hikes ranging from three to four times, each by 25 basis points. Capital markets generally expect the Bank of England to delay an interest rate hike to December. Morgan Stanley has postponed the timing of the Bank of England's rate hike from July to November and warned that if economic downturn pressures are weaker than expected, a lag in rate hikes could lead to a second rebound in inflation, putting the Bank's policy in a passive position. Outlook: Sustainability of the ceasefire agreement remains a key variable Although the decline in inflation expectations has provided the Bank of England with policy space, the outlook still faces significant uncertainty. The Bank of England lowered its forecast for the peak inflation rate in the fourth quarter to over 3.25%, still higher than May's 2.8%. Bailey emphasized in the statement that the high energy prices in the past four months have already indicated that some inflation pressure is building up. The minutes of the Monetary Policy Committee meeting showed that the members unanimously believed that if inflation continued to rise, "appropriate policy responses should be firm and strong." The committee reiterated that they were "prepared to take necessary actions at any time to ensure that CPI inflation returns to the target of 2% in the medium term." The sustainability of the US-Iran ceasefire agreement remains the biggest uncertainty for the market. While the ceasefire news boosted market confidence, the Bank of England warned that the restoration of energy supply faces risks of logistics delays and instability will persist. Once geopolitical tensions rise again, energy prices could quickly rebound, leading to a rise in inflation expectations once again. Meanwhile, the UK real economy has shown signs of weakness. The latest data shows that GDP fell by 0.1% month-on-month in April. The contraction in April GDP was mainly due to the rise in energy prices and inflation expectations triggered by the Middle East conflict, with the service industry contracting by 0.2% month-on-month as the main drag. June's PMI data further confirms the weakening economic momentum. Data released by S&P Global shows that the UK's composite PMI fell from 49.7 to 49.4 in June, remaining in the contraction zone below the 50 threshold for the second consecutive month, hitting a 14-month low and falling short of the expected 50.6. The service sector PMI fell from 49.3 in May to 48.7, hitting a 41-month low, lower than all economists' forecasts. The manufacturing PMI fell from 53.9 to 53.1, also below expectations. Cathal Kennedy, a capital market analyst at the Royal Bank of Canada, said that the preliminary PMI data for June in the UK suggests that economic growth could significantly slow down in the coming quarters. After experiencing the fastest growth among the G7 countries in the first quarter, the UK economy is facing the prospect of stagnation or even negative growth in the second quarter. The Bank of England is currently in a dilemma: inflation remains high while the growth engine is clearly slowing down. The committee believes that weakened demand and loosening job market could alleviate the secondary transmission pressure of inflation to some extent, but it also highlights the complexity of balancing between anti-inflation and stable growth.