UK CPI inflation held steady at 2.8% in May, lower than predicted, with a rise to 3% broadly expected.
CPI fell to 2.8% in the year to April, down from 3.3% in March and 0.2% lower than economists expected. As a result, many economists had expected a bounce-back in inflation amid ongoing political uncertainty and inflated energy prices.
Industry experts now widely predict a hold in interest rates at the Bank of England's meeting tomorrow, with others predicting that softer inflation "could trigger a mortgage price war".
Lindsay James, investment strategist at Quilter, commented: “After inflation surprisingly dropped below 3% last month, it has managed to keep pace at the same rate, 2.8%, surprising the market which expected it to bounce back. While the war in the Middle East is over, for now, and normality can supposedly resume, inflation has managed to hold steady, though the likelihood is that it won’t suddenly start falling for a number of months. As a result, today’s figure is a pleasant surprise.
“Going forward, the picture looks more complicated. The energy price cap will rise 13% from July as a result of elevated oil and gas prices, so the benefits of the US-Iran resolution will not be immediately felt. Indeed, food prices are likely to see greater impact from higher costs of production as the cost and availability of fertiliser, energy and transportation remains restricted until the Strait of Hormuz is fully opened again. Meanwhile, there are increasing concerns we are likely to see the most powerful El Nino weather system on record in the months ahead, which has the potential to ruin crops and harvests.
“Despite the good news on inflation, the Bank of England is expected to retain interest rates at 3.75% when it meets on Thursday. With growth already experiencing headwinds from higher oil prices, the problem of inflation in this situation will be resolved not by a rate rise but by an easing of supply chains. With the Middle East situation looking somewhat calmer, that can hopefully take rate rises off the table. But to avoid such a situation happening again, the government needs to act swiftly to decouple the UK from the harshest impacts of such events.”
Luke Bartholomew, deputy chief economist at Aberdeen, said: “With inflation coming in softer than expected again, the pressure on the Bank of England to hike rates this year will continue to fade, although there may still be a couple of policymakers who vote for a rate increase tomorrow. Despite energy prices having fallen recently, there is more inflationary pressure to come for the UK, when the Ofgem price cap moves higher next month. So, the Bank will still want to remain vigilant to the impact of higher household energy bills on broader inflation expectations. But with the economy otherwise relatively weak, it is plausible speculation begins to turn once again to when the Bank will cut rates again, not hike.”
Samuel Fuller, director of Financial Markets Online, commented: “This was a huge upside surprise. Many marketwatchers were convinced that April’s relatively modest inflation number was a fluke.
“While services inflation came in hotter than forecast, most other numbers in the May report are a cooling balm for markets braced for soaring prices, and with them the chance of interest rate rises.
“While still well above the Bank of England’s 2% target, May’s annual CPI number almost feels benign.
“All this means the Bank has no reason to increase interest rates any time soon. It’s instead likely to watch and wait, and if inflation stabilises further it may hold off on making any rate rises at all this year.
“This is a huge turnaround, as just a few weeks ago the swaps market was forecasting two 0.25% base rate rises by the end of 2026.
“Cue huge relief for the 1.8 million homeowners who are due to remortgage over the next year. The UK’s rapidly changing interest rate outlook could trigger a price war between mortgage lenders, many of whom will want to cut rates to make themselves more competitive."
David Hollingworth, associate director at L&C Mortgages, added: “It was expected that there would be an increase in the rate of inflation in May, after the larger than anticipated fall in April’s figures, so to hold steady will come as a nice surprise. That should be a boost to mortgage borrowers who would have no doubt been accepting of a small rise in the rate of inflation but fearing a bigger jump.
“Today’s figures should help to cement the majority view that the Bank of England base rate will be held tomorrow, despite MPC members holding differing views on whether and when rates need to climb.
“With no disruption to the market’s expectation of another hold, there shouldn’t be any negative impact on an improving picture for mortgage rates. Markets have priced in potential interest rate rises since the conflict began, which forced mortgage rates higher. However, since then fixed mortgage rates have eased back.
“The announcement of a peace deal has seen swap rates fall back and today’s figures should help that to continue. Mortgage lenders have been quick to pass on those benefits to borrowers. Although reductions have tended to be relatively small and frequent, it’s helped to drag rates down for borrowers.
“Despite the uncertainty that remains we should see further, gentle cuts feed through. Although it’s unlikely that rates will plummet, it does at least give mortgage borrowers a more positive outlook than only a few weeks ago."
