UK reaction: Inflation comes in above expectations, but June cut still on the cards

March’s smaller-than-expected fall in consumer price inflation (CPI) will be a concern for the Bank of England’s Monetary Policy Committee (MPC) but we don’t think it will be enough to dissuade it from cutting interest rates in June. The headline rate slowed to 3.2% in March – its lowest rate since September 2021 – from 3.4% in February; however, forecasters and the Bank of England had expected a sharper drop to 3.1%. Core CPI inflation - which excludes food and energy - also came in above the expected 4.1%, dropping to 4.2% from 4.5% in February. Retail price inflation (RPI), meanwhile, fell to 4.3% (expected 4.2%), while the Retail Price Index excluding mortgage interest payments (RPIX) eased to 3.3%.

On the positive front, food CPI inflation continued to slow, rising by 4% on the year ‑ its slowest pace since November 2021 – knocking off 0.11 percentage points (ppt) from the headline rate. Clothing and footwear inflation also fell back, mainly due to smaller-than-usual price increases as new season stock entered the shops; it shaved off 0.06ppt from the headline. Core goods inflation also dropped back further, falling to 1.5% from 1.9%. These downward contributions, however, were partially offset by a rise in motor fuel which increased to -3.7%, from -6.5% in February; this upward trend likely will continue if oil prices continue to rally. Services inflation was also stickier than many had anticipated, ticking down to just 6.0% from 6.1%, due to stronger housing services and communication CPI inflation - both the MPC and forecasters had expected a fall to 5.8%.

This data will make the MPC nervous, particularly given CPI’s recent stubbornness in the US. But we doubt this alone is enough to tip the scales away from a June cut. Indeed, we still expect the headline rate to broadly return to the 2% target in April, as the adjustment in energy regulator Ofgem’s price cap causes energy to knock off around 0.5ppt in addition to further slowdowns in food CPI and core goods inflation. The headline rate will admittedly rise above the target in the latter part of the year, posting readings between 2% and 2.5%, as the downward contribution from energy eases and services inflation remains sticky. But with unemployment edging up, we think services inflation will drop to the 3% to 3.5% range that is needed to keep the headline rate sustainably at target towards the end of this year. Further ahead, we see downside risks to the Bank of England’s CPI inflation forecasts next year.

Bank of England Governor Andrew Bailey also added to previous comments yesterday, stating that he has seen “strong evidence now that the process is working its way through”, adding the “dynamics of inflation are rather different between Europe and the US”. All considered, we think a June rate cut still looks most likely with two further cuts in September and November. Nevertheless, if inflation and wage growth continue to come in above expectations over the next month or two, the first cut will likely be pushed back to August.

Market reaction was relatively muted. The pound ticked up against the dollar to $1.2440 compared to $1.2420 and edged away from its recent 5-month lows against the euro, ticking up to €1.1720, from €1.700.