CPI inflation confounded expectations in May, staying unchanged (at 8.7%), instead of continuing to fall as most analysts had predicted (to around 8.4%). The latest data has reinforced concerns that the UK’s inflation problem may prove more difficult to shift than previously expected.
On the plus side, the data showed signs of more globally-centric price pressures receding: food price inflation softened (but was still very high, at 18.3%) and fuel prices fell by 13% on a year ago – the largest decline since the height of the first COVID lockdown in June 2020. Encouragingly, there were also signs of pipeline price pressures receding, with manufacturing input prices falling in annual terms, for the first time in two-and-a-half years.
However, the data also stoked concerns around the persistence of inflation. The drags from food and fuel prices were offset by a broad range of price rises elsewhere – such that “core” CPI inflation (which excludes food and fuel) actually rose in May (to 7.1%). Combined with the uptick in services inflation (to 7.3%) and the recent strength in private sector wage growth, this paints a picture of greater persistence in more domestically-focused price pressures.
This is something that the Bank of England’s Monetary Policy Committee (MPC) have explicitly flagged concern about in their recent communications. The latest inflation data came a day before the MPC’s June meeting, and so further bolstered expectations that the Committee would raise interest rates again. The MPC did not disappoint, raising rates by an outsized 50 basis points (to 5%). Minutes of the Committee’s meeting stated that they were responding to the “significant upside news” in a range of data – headline and services CPI inflation, private sector wage growth and labour market activity – which indicated more persistence in price pressures.
The latest rate rise comes after much scrutiny around movements in market interest rates over the last few weeks, which have led many lenders to re-price fixed mortgage deals. The latest move from the Bank of England will likely reinforce this further, particularly given the larger-than-expected hike in rates.
Looking ahead, we still expect CPI inflation to fall over the course of this year, despite the upside surprise in May – particularly as large base effects from food, fuel and energy price inflation continue to run off. But inflation is still set to remain relatively high this year; we expect it to stand at over 4% at the end of 2023, more than double the Bank of England’s target. And the persistence of domestic price pressures reiterates that the risks to our inflation forecast are firmly to the upside.
This also raises the likelihood of more rate rises from the Bank of England. Financial markets are pricing in a peak in interest rates of around 6% next year. It’s unclear how likely a scenario this is at present, with further moves by the MPC heavily dependent on developments in economic data over next few months. But while such strong expectations for rates looked unwarranted a few weeks ago, they now seem very much within the realms of possibility.
For more detail on the outlook for economic growth, inflation and monetary policy, see the CBI's latest economic forecast.