As expected, food prices had a favourable impact on July consumer prices, cutting the annual increase by 0.14%. This effect, however, was offset by a pick-up in "core" inflation, resulting in the headline CPI rise remaining at 1.8%. This is well above the Inflation Report forecast of average inflation of about 1.25% in the third quarter and casts doubt on Bank of England Governor Mervyn King's suggestion of a fall below 1% later in 2009.

The CPI excluding food, energy, alcohol and tobacco rose by an annual 1.8% in July, up from 1.6% in June and the highest since November. Based on recent National Statistics research, this measure of core inflation would probably stand at 2.4-2.5% in the absence of December's VAT cut.

Stubborn core trends partly reflect the continuing impact of last year's sterling depreciation but also call into question consensus and Bank of England estimates of the sensitivity of inflation to rising economic slack. An alternative forecasting approach based on monetary growth may be more consistent with recent numbers than "output gapology" – see previous post.

Retail prices were down by an annual 1.4% in July but this compares with a 1.6% June decline. Interestingly, the housing depreciation component of the RPI – linked to house prices – rose last month for the first time since June last year. As argued in the previous post, RPI inflation should rebound strongly and exceed CPI inflation in 2010 as housing and interest rate effects unwind.