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Jul 18, 1:40 PM EDT

UK inflation unexpectedly falls and eases rate-hike fears

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LONDON (AP) -- Inflation in Britain unexpectedly fell in the year to June, official figures showed Tuesday in a development that's eased market expectations that the Bank of England will raise interest rates soon.

The Office for National Statistics said consumer prices were 2.6 percent higher in the year to June, down from 2.9 percent the previous month. The consensus was that inflation would rise to 3 percent, which would have been a full percentage point higher than the Bank's target rate.

The surprise fall, the first since last October, was largely due to falling gas prices at the pump as lower wholesale crude prices were passed on to drivers. Despite the fall, living standards in Britain are still falling as price increases outpace wage rises.

Inflation has risen sharply from last June's 0.5 percent, largely because the country's vote to leave the European Union triggered a 15 percent drop in the value of the pound. Though a lower pound may help exporters sell their wares in international markets, all other things being equal, it makes imported goods such as food and energy more expensive.

The spike in inflation over the past year has caused concern among some rate-setters at the Bank of England. Last month, three of the eight members of the bank's Monetary Policy Committee voted to increase the benchmark interest rate by a quarter-point from the record low of 0.25 percent. The rest, though, while acknowledging the inflation spike, thought a rate hike could be counterproductive for the British economy, which grew by less than any other Group of Seven country in the first quarter of the year.

The main uncertainty surrounding the British economy relates to Brexit and what trading relationship the country will have with the EU after it leaves the bloc in March 2019. The British government has only just started full-scale Brexit discussions with the EU and there are fears that the country could end up crashing out of the bloc with no deal, which could result in tariffs being slapped on British goods.

The pound fell sharply after the inflation data as traders priced in a lower interest rate profile. By late afternoon London time, the pound was 0.2 percent lower at $1.3027. Though that may not seem much, the currency had earlier risen to $1.3126, its highest level since last September, as traders bet that the inflation data would be higher than anticipated and potentially force the hand of the bank to raise interest rates soon.

Ben Brettell, senior economist at stockbrokers Hargreaves Lansdown, said easing inflation, if sustained, could help shore up the British economy in the months ahead as economists had expected real incomes to continue to fall with negative repercussions for retail sales.

"If this fails to materialize the economy could see a stronger second half to the year," he said.

Economists remain split as to how inflation will pan out over the coming months, largely because there's uncertainty surrounding the value of the pound. However, if the currency stabilizes then the impact of last year's depreciation will start to drop out of the annual comparison and that could see inflation fall back toward target and help support the economy.

But as with almost everything about Britain, Brexit will remain the driver.

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