UK Inflation Holds at Highest in Over a Year Before BOE Vote
UK inflation remained at its highest in over a year, keeping price pressures uncomfortably strong as the Bank of England weighs how much energy market turmoil will affect its path to cutting interest rates.
Consumer prices rose 3.4% in May from a year earlier, slightly above the 3.3% increase expected by economists, Office for National Statistics figures published Wednesday show. Upward pressures on inflation came from food prices, which rose at their fastest pace since early 2024.
While inflation was officially recorded as 3.5% in April, the statistics body later acknowledged that it had uncovered a mistake and the rate should have been 3.4%. The error was blamed on incorrect vehicle excise duty numbers from the government.
Services inflation — which is being closely watched for signs of domestic pressures — eased to 4.7% from 5.4%, in line with BOE forecasts.
It leaves inflation stubbornly elevated ahead of the BOE Monetary Policy Committee’s interest-rate decision on Thursday. Officials are contending with a cooling economy and labor market against sticky services inflation and rising oil prices after the escalation in tensions in the Middle East.
The conflict between Israel and Iran risks complicating upcoming BOE decisions with oil prices up around 14% compared to a week ago. While investors and economists don’t expect a rate cut tomorrow, the BOE is likely to keep the door open to another move at its August meeting.
“Energy prices have emerged as a key risk to the inflation outlook following the escalation in the Middle East,” said Yael Selfin, chief economist at KPMG UK. “This presents another challenge for the Bank of England to navigate and tomorrow’s meeting is unlikely to result in a shift from the MPC’s cautious approach.”
The pound extended gains after the data, rising as much as 0.3% to $1.3462. Traders slightly pared bets on further interest-rate cuts from the BOE, with swaps pricing 47 basis points of easing by year-end from 49 basis points on Tuesday.
ONS acting Chief Economist Richard Heys said air fares and fuel costs fell in May but that was offset by rising food prices, particularly chocolates and meat, as well as furniture and household goods, including fridge freezers and vacuum cleaners.
Goods inflation picked up to the highest since 2023, while food prices rose at the fastest pace in over a year. Retailers have warned that firms are passing Chancellor of the Exchequer Rachel Reeves’ recent increase in payroll taxes onto consumers through higher prices.
Markets see an 80% chance of the BOE lowering its base rate by a further quarter-point by the end of the summer with two cuts almost fully priced in for this year.
After weighing on inflation in May, petrol prices are likely to rise sharply after the latest conflict between Israel and Iran drove up oil prices.
Bloomberg Economics Chief UK Economist Dan Hanson estimates current levels of oil prices, up around $10 to $75 a barrel, would add 0.1 percentage point to inflation later this year. That would take peak inflation to 3.8%. If oil prices hit $85 a barrel, UK inflation will peak at 4%, double the 2% target, he said.
Sanjay Raja, chief UK economist at Deutsche Bank, said the rise in oil prices “will undoubtedly complicate” the task facing the MPC. “Higher energy prices will mean higher inflation expectations,” he added.
Officials remain cautious over reducing borrowing costs too quickly, with inflation expected to stay elevated, driven by energy bills and a raft of regulated price increases. The central bank accurately predicted the inflation rate in May, which it expects to stay at 3.4% through the summer before peaking at 3.7% in September.
The forecasts were made before the overstatement of the number of vehicles subject to VED rates in their first year was disclosed, and the use of correctly weighted data from last month may have the effect of keeping inflation lower than it would have been otherwise.
With longer-term inflation expectations still stubbornly high, officials are alive to the risk of second-round effects on wages and prices. They nonetheless believe that underlying price pressures are in retreat, and recent falls in employment may also persuade them to continue easing.
Bloomberg’s survey showed economists expect a 7-2 split in favor of keeping rates at 4.25% on Thursday. Dovish officials Swati Dhingra and Alan Taylor are seen as most likely to vote for further rate cuts.
The mistake in April’s inflation data is just one of many factors muddying the inflation picture at a vital moment as BOE. Ongoing doubts over the quality of official employment data are also making it more difficult for economists to read price pressures.
Source : Bloomberg
