"Indications currently suggest that the Committee may look to continue to hold fire to see how the economy tolerates higher rates."
- Derrick Dunne, CEO of YOU Asset Management
CPI inflation fell to the Bank of England's 2% target in May, down from 2.3% in the previous month, the latest ONS figures show.
CPI last hit 2% in July 2021, almost three years ago, and has fallen from its peak of 11.1% in October 2022.
On a monthly basis, CPI rose by 0.3% in May, compared with a rise of 0.7% in May 2023.
CPIH inflation, which includes owner occupiers’ housing costs, rose by 2.8% in the 12 months to May, down from 3.0% in the 12 months to April.
The largest downward contribution to the monthly change in both CPIH and CPI annual rates came from food, with prices falling this year but rising a year ago; the largest upward contribution came from motor fuels, with prices rising slightly this year but falling a year ago.
Core CPI inflation (excluding energy, food, alcohol and tobacco) rose by 3.5% in the 12 months to May 2024, down from 3.9% in April.
However, despite falling inflation across all metrics, industry experts predict that the Bank of England will leave Bank Rate unchanged in tomorrow's meeting.
Susannah Streeter, head of money and markets at Hargreaves Lansdown, commented: “It’s been a long time coming, but finally inflation has hit the Bank of England’s target. The last time inflation stood at 2% was in the run up to the Euros in July 2021, just before pent-up demand was unleashed while pandemic restrictions eased. As fans toast the tournament once more, seeing inflation finally return to target might be seen as a reason to put out more bunting, given how painful the cost-of-living crisis has been.
"But it doesn’t look like the Bank of England will join the celebratory party immediately and cut interest rates tomorrow. Policymakers still have their eye on hot wage inflation, with earnings including bonuses still running at 6%, at the last count.
"There will be concerns that services inflation has only retreated slightly, so although August remains a possibility for a rate cut, September is looking more likely – and the markets are only fully pricing in a rate cut in the Autumn.
"It is clear that disinflationary pressures have been building up through the UK economy. The effect of unemployment ticking up to 4.4% in April may have made some workers more cautious in their spending patterns. That certainly showed up in the latest economic growth figures, which showed activity in the retail sectors slowing sharply. The risk is that if borrowing costs stay high through the summer, the economy may struggle to shift meaningfully out of stagnation mode.
"There are signs that more consumers are increasingly financially resilient and may be willing to spend more, helping support the economy in the months to come, especially given the big sporting events filling calendars. But longer-term investment will still be needed to provide an engine of growth.”
Peter Stimson, head of product at MPowered Mortgages, said: “There’s a brutal irony to the timing of today’s good news. For almost three years, high inflation has prevented the Bank of England from reducing interest rates.
“Now CPI is bang on the Bank’s 2% target, the Bank’s next step would ordinarily be to start easing the interest rate pain which has made mortgages more expensive for millions of homeowners and would-be buyers.
“But it’s unlikely to do so, as the inflationary block has morphed into an electoral one.
“While the Bank is independent of Government and not part of the Civil Service, it too is in de factor purdah – and cannot be seen to influence the election.
“The members of its rate-setting committee are therefore unlikely to cut the Base Rate tomorrow, even if they wanted to.
“Not so long ago, Governments set interest rates – and were often accused of abusing this power to win votes at election time.
“A quarter of a century ago, this power was taken away from politicians and given to the Bank of England, precisely to prevent this happening.
“Then there’s the tricky matter of core inflation. Despite the welcome fall in the headline CPI figure, core inflation remains stubbornly high at 3.5%. This is well above the Bank’s target, and its rate-setters will want to see further improvement here before committing to a rate cut.
“So even though mortgage borrowers and lenders are crying out for the Base Rate to start coming down now, we are likely to have to wait until after the election – and probably until August – before relief finally comes.”
Derrick Dunne, CEO of YOU Asset Management, added: “It has been a two year struggle to get inflation back to target, but we’re finally there. Notably inflation is now lower than in both the Eurozone and US, which makes what the Bank of England does tomorrow all the more interesting.
“The Bank of England takes lots of factors into account when deciding where its bank rate should be set, including GDP, employment and wage data and other metrics. But ultimately, it is inflation which dictates where rates should be as this is its core mandate. Indications currently suggest that the Committee may look to continue to hold fire to see how the economy tolerates higher rates.
“GDP flatlined in April but was stronger earlier in the year, while wages are now outstripping inflation with no sign of a wage price spiral. The MPC may, therefore, be reluctant to go too hard on cuts if the economy is putting up with current financial conditions. But the outlook is something of a puzzle for rate setters as to cut now could be taken as a gamble that easing conditions won’t reignite demand and therefore price rises."
