UK reaction: Back at target

The headline inflation rate is now back at the Bank of England’s (BoE) target of 2%. While today’s data will not have turned the dial on tomorrow’s Bank of England meeting – we expect no change from May’s meeting – we still think the Bank will press ahead with the first cut in August, despite slightly stickier services inflation. The headline rate ticked down to 2.0% – back at target for the first time since July 2021 – from 2.3% in April, bang in line with analysts’ expectations but slightly above the MPC’s forecast, 1.9%. Core inflation also ticked down, to 3.5%, also in line with analysts’ forecast.

Food CPI inflation continued to apply downward pressure on the headline rate, having risen 1.7% on the year to May 2024 – its lowest rate since October 2021 – compared to 2.9% in April. Prices actually fell 0.3% on the month. Furniture and household goods also added to the drop in the headline rate, rising by just 0.2% on the month, compared with a 1.1% monthly rise in May 2023. Transport inflation, however, rose to 0.3% in May, from a fall of 0.1% in April on the back of rising motor fuel prices. Indeed, the average price of petrol rose 0.7 pence per litre in May, resulting in the motor fuel price inflation rising by 2.3% in May, compared with a fall of 0.3% in April.

Admittedly, services inflation remained sticky; it fell to 5.7%, from 5.9%, a fall to 5.5% had been expected by analysts and 5.4%, by the Bank of England. The good news, though, is that the upward pressure was concentrated. Indeed, while transport services inflation rose to 2.5%, from 1.7%, due to rail, air and sea fares rising by more than a year ago, sectors most sensitive to the near 10% National Living Wage hike broadly saw price pressures ease. Indeed, recreation and cultural services inflation knocked 0.07 percentage points off the headline rate, due to easing price increases in package holidays, books, and pet products. Accommodation inflation and catering services inflation also eased.

Looking ahead, the headline rate looks set to remain around the 2% target in June, before ticking up again in July, as Ofgem’s Energy Price Cap falls by less than it did a year ago. Note, though, that the headline rate will probably rise no higher than around 2.5% in the second half of this year, as core goods CPI inflation remains in negative territory and food CPI inflation falls further. In addition, we expect to see services inflation continue to tick down over the coming months, in part due to base effects following the chunky increases in 2023. More broadly, the MPC will have been buoyed by the softer-than-expected labour market data in April and will see a further round of both labour market and inflation data before their meeting in August. Asa result, we remain comfortable with our call for the first 25bp cut in August, with a further one in November.