UK inflation softens ahead of Bank of England meeting

UK inflation remained unchanged last month, in another sign that the Bank of England's monetary policy committee meeting on Thursday will see no changes to interest rates.

The consumer prices index rose 0.2% month-on-month in May, according to figures from the Office for National Statistics. This was down from the 1.2% spike in April and in line with the average economist forecast.   

It meant annual CPI inflation remained at 3.4% for a second month, also in line with forecasts, but still well above the BoE's 2% target.

The ONS initially said that CPI has eased from 3.5% in April to 3.4%, but later corrected this. 

Core CPI, which excludes more volatile prices such as energy and food, fell to 3.5% from 3.8%, again as expected.

Services CPI, a key measure for the BoE committee, also softened to 4.7% from 5.4%, more than the 4.8% forecast.

Annual inflation only changed slightly in May, said ONS acting chief economist Richard Heys, due to "a variety of counteracting price movements".

He pointed to a fall in air fares in the month compared with a large rise at the same time last year, while motor fuel costs fell and this year saw a later Easter and school holidays, which also affected pricing. 

“These were partially offset by rising food prices, particularly items such as chocolates and meat products," Heys said. "The cost of furniture and household goods, including fridge freezers and vacuum cleaners, also increased."

Inflation puzzle

Danni Hewson, AJ Bell head of financial analysis, said: "The problem with inflation data is that it’s looking back at what has already happened, whilst households have to look forward at what is to come.

"The price at the pump played a big part in the slight fall in headline inflation but the escalating conflict between Israel and Iran has impacted the oil price in the past week, with UK motorists already bracing themselves for hikes and airfares also expected to soar."

She added that the ONS had confused people about due to an error in vehicle excise duty numbers, which meant "people might be puzzled by differing headlines".

“Whether the headline rate has fallen slightly or held steady, it’s still significantly above the Bank of England’s target of 2%. Market expectation of a rate cut by the MPC when it meets tomorrow has actually climbed slightly to 12% and looking at today’s figures there could be a degree of wiggle room," Hewson said. 

Raj Badiani, economics director at S&P Global Market Intelligence, said he does not expect the MPC will vote for a second successive rate cut at tomorrow’s meeting.

While he anticipates tamer inflation developments during the second half of this year, as soft demand conditions and accelerating employment losses are likely to result in slower earnings growth, Badiani says "the timing of the next interest rate cut is uncertain because of significant upside inflation risks" from a new spike in global oil and gas prices because of the intensifying conflict between Israel and Iran.

In this case, he says UK firms could ratchet up their prices to cover higher payroll costs and headline and services inflation rates "could be higher than we currently anticipate during the next few months, delaying the next rate cut until this November or early 2026".

Monica George Michail, associate economist at NIESR, forecast inflation will remain above 3% for the remainder of the year. "amidst persistent wage growth and the inflationary effects from higher government spending".

"Additionally, the current tensions in the Middle East are causing greater economic uncertainty. We therefore expect the Bank of England to keep rates on hold this Thursday and implement just one further cut this year."

Matt Swannell, chief economic advisor to the EY ITEM Club, says headline inflation is "likely to edge upwards over the next few months, and the increase could be more pronounced if the recent rise in Brent Crude Oil prices is sustained.

"But we expect inflation to cool from October, as the positive contribution from the energy category wanes."

Nicholas Hyett, investment manager at Wealth Club, noted that UK the price of Brent crude oil has moved sharply higher despite key global oil routes remaining largely unaffected so far, so the conflict has the potential to further disrupt energy flows than it has so far.

"As a key input into pretty much everything, a spike in oil would drive up prices across the board," Hyett said. "The inflationary risk from the Middle East, combined with already rising prices, could change the calculus for the Bank of England and make rate cuts that bit less likely."

  ** Update: Adds details, economist comments **