Inflation drops more than expected – don't expect interest rates to follow

Inflation slowed by more than expected in the latest reading on Wednesday (22 July) – but experts don’t think that interest rates will follow this year.

The consumer prices index (CPI) measure of inflation hit 2.6 per cent in the year to June, down from 2.8 per cent a month earlier.

Most economists had expected a fall to around 2.7 per cent.

But experts expect the figure to pick up from next month once July’s energy price rises are factored in to the equation. As a result, they say that cuts to the Bank of England base rate in 2026 are probably off the table.

What happened to inflation – and what will happen next?

In June’s figures, CPI dropped to 2.6 per cent – the lowest rate since March last year. A spike is expected in July though, because the price cap on energy prices rose by 13 per cent at the start of the month.

“The UK will see inflation push higher from here – potentially pushing closer to 3.3 per cent to 3.5 per cent in the fourth quarter of the year as base effects, food price rises and energy price rises catch up with households,” said Sanjay Raja, chief UK economist at Deutsche Bank Research.

What will happen to interest rates?

The Bank of England base rate, colloquially called interest rates, sits at 3.75 per cent. The rate tends to come down as inflation looks like it’s heading towards the Bank’s 2 per cent target.

Experts think the spike in inflation expected later this year will prevent the Bank from cutting rates this month, or indeed throughout 2026. But they don’t expect any hikes either.

Raja said the higher inflation rate later this year would “continue to keep any prospect of rate cuts off the table for now”.

Paul Dales, the chief UK economist at Capital Economics, added: “We still expect the Bank of England to leave interest rates on hold at 3.75 per cent all this year and cut them to 3 per cent next year.

“Obviously, a lot depends on what happens to energy prices. The risk is that energy prices rise further and this prompts the Bank to raising interest rates once or twice.”

Energy prices are heavily dependent on oil prices, and an escalation of the war in the Middle East could send these higher than they are.

“Interest rates are likely to stay on hold next week, but the Bank will be wary about a resurgence in inflation later this year, especially given oil and natural gas prices have risen sharply recently. That suggests no rate cuts until 2027,” said Thomas Pugh, an economist at RSM UK.

What does this mean for mortgages?

The Bank of England interest rate affects mortgage rates in numerous ways.

No cuts or rises means that borrowers with variable or tracker mortgages will see their home loan price stay the same throughout this year – if predictions are correct.

The effect on fixed-rate mortgage prices is different. These mortgages are heavily priced on swap rates, which follow predictions of where the Bank of England base rate will go next.

Rising oil prices in the past few days – because of tension in the Middle East – have raised swap rates, and mortgage prices have gone up as a result.

“Mortgage rates had been falling across the board, but this week has seen them jump significantly, as the markets began to expect earlier rate rises, and swap markets started to price them in,” said Sarah Coles, head of personal finance at AJ Bell.

She added: “This demonstrates how difficult it can be to second-guess where the mortgage market is heading at a time of such uncertainty. It’s also why it’s not worth hanging on for rates to hit a magic number, even if the market has been moving in one direction for a while.

“Instead, if you have a remortgage due in the next six months, check if you can agree a deal for your remortgage now. If rates fall from here, you can shop around elsewhere, but if they rise again, you’ll have locked in a competitive rate.”