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After costly policy reversals by her boss and an unexpected shrinking of the economy, the last thing the Chancellor needed was an inflation shock.

Yet that’s exactly what Rachel Reeves has been handed.

Figures published by the Office for National Statistics (ONS) on Wednesday showed inflation accelerated to 3.6pc in June, leaving Britain with the highest rate among G7 countries, according to the latest data available.

This is firmly above the Bank of England’s 2pc target, which makes it harder for the Bank’s boss, Andrew Bailey, to help Reeves out by cutting interest rates in the face of the slowing economy and deteriorating jobs market.

Despite slumping employment and slowing pay growth, investors are now less confident of a rate cut next month, though it is still likely, and hopes of action later in the year are also fading.

“Unfortunately for the BoE, things will likely get worse before they get better,” warns Zara Nokes, at JP Morgan Asset Management.

Higher-for-longer interest rates will elevate the Chancellor’s borrowing costs and drag on growth. It adds to the Chancellor’s many woes ahead of what looks to be another painful autumn Budget

Reeves own goal

Inflation jumped by more than expected in June to its highest level in more than a year. ONS figures show that consumer prices rose by 3.6pc in the 12 months to June, up from 3.4pc in May. This is the highest rate since February last year. The rise was 0.2 percentage points above analyst expectations.

The most problematic aspect of the UK’s high inflation rate, which is well above the Bank of England’s 2pc target, is how much it differs from similar countries.

It is by far the highest inflation rate of any G7 country, though Japan’s June reading is due later this week.

In fact, other large European economies are struggling more with low inflation, a sign of households and businesses feeling nervous and reluctant to spend.

Prices are rising by 0.8pc in France and 1.7pc in Italy. In Germany, meanwhile, prices in June were exactly 2pc higher than a year ago – the holy grail for rate setters.

Even in the US, where Donald Trump is actively driving up prices with his aggressive and controversial tariffs, inflation was just 2.7pc last month.

Only in Japan have prices risen faster than in the UK this year – but its inflation rate is forecast to ease to 3.3pc in June when final numbers are reported.

“The UK is again becoming an international outlier to the upside on inflation,” warns Andrew Wishart at Berenberg. “The problem stems entirely from domestic price pressures, which have been exacerbated by the Government’s choices on the minimum wage and employers’ National Insurance contributions.”

In other words, Reeves has hardly helped herself by hitting employers with the twin pressures of a £25bn tax raid and another inflation-busting minimum wage rise.

Both took effect in April, when bills typically rise and the energy price cap also went up. June’s inflation data suggests businesses are passing much of this increased cost on to customers in the form of higher prices.

Food for thought

The ONS said the jump in inflation was driven by higher food prices and transport costs, in particular petrol and diesel prices.

It comes after the war between Israel and Iran prompted a spike in oil prices. Oil has fallen from a peak seen at the start of the year but remains higher than it was at the start of June.

Flight tickets also rose by 7.9pc between May and June, the fastest rise for this time of year since 2018.

While these factors are largely outside the Government’s control, food prices have risen every month since Ms Reeves’s National Insurance tax raid on employers took effect in April.

Richard Heys from the ONS said: “Food price inflation has increased for the third consecutive month to its highest annual rate since February of last year.”

Food prices rose by 4.5pc in the year to June, climbing from a rate of 4.4pc in May. It follows warnings from retailers that this would be an inevitable consequence of surging employment costs.

“Despite fierce competition between retailers, the ongoing impact of the last Budget and poor harvests caused by the extreme weather have resulted in prices for consumers rising,” says Kris Hamer at the British Retail Consortium.

“The price of many staples rose on the previous month, including bread, rice and pasta.”

Struggling economy

The timing could hardly be worse for the Chancellor.

After fast growth at the start of the year, the economy has effectively ground to a halt. It shrank by 0.1pc in May, after declining by 0.3pc in April.

Tariffs, tax rises and global uncertainty have left bosses fearful. The latest figures from the professional body for chartered accountants ICAEW show confidence among business leaders is at a three-year low.

It is perhaps unsurprising, then, that the employment market is in a sorry state. Companies are only advertising 736,000 jobs – the lowest outside of Covid since spring 2015.

Employment has dropped by 178,000 over the past year, according to official data, with retail and hospitality particularly hard hit by tax rises.

Over the past year, pubs, restaurants and other hospitality businesses have lost more than 108,000 payroll jobs, with retail and wholesale down more than 65,500. These sectors are the most exposed to higher NICs and the minimum wage, and often give young people their first jobs.

Kate Nicholls, chairman of the trade body UKHospitality, has called the tax changes “socially regressive”.

“Without a change of tack from the Government we could be looking at even more job losses in hospitality, when we should be bringing people into the jobs market,” she added.

The biggest growth sector is health and social work, with an extra 67,000 staff on payrolls, amid a surge in government spending.

The unemployment rate is at its highest level since just after the final lockdowns ended, at 4.7pc.

All of this makes for grim reading in Downing Street.

What it means for rates

For policymakers at the Bank of England, meanwhile, it means any decision they make is a gamble.

Cutting interest rates too slowly risks placing unnecessary burdens on already-struggling businesses and leaving lots of people unemployed.

Move too fast, however, and already high inflation could run out of control.

Mr Bailey, the Bank’s Governor, has suggested a weakening job market could make him act more decisively. But while markets are still pricing in a rate cut from their current level of 4.25pc in August and another one later in the year, economists are starting to worry.

“August will be a close call,” says Wishart. “If the data between now and Aug 7 suggest price pressures will remain high and the labour market is stabilising, a majority for a pause in interest rate cuts should emerge.”

Yael Selfin, chief economist at KPMG, says: “Today’s data suggests underlying inflationary pressures remain persistent. This is unlikely to ease concerns about the potential second-round effects from the tax measures and may reinforce the Monetary Policy Committee’s cautious stance ahead of next month’s meeting.”

All of this could spell further trouble for Reeves. While higher inflation tends to boost receipts for the Treasury, it also adds to costs. On top of that, investors in gilts – as UK government bonds are known – are on edge.

Government borrowing costs jumped after the ONS inflation numbers came out, with yields on 10-year gilts up by four basis points to 4.66pc.

“Markets must be starting to question the prospect of an August rate cut,” says former rate setter Andrew Sentance.

If hopes of a rate cut do dwindle, it will be yet another blow for an unhappy Chancellor desperately battling to get her budget back on track.