Inflation reaccelerates as energy shock takes hold

Core inflation cools but pump-prices add upwards pressure, says Rathbones’ Adam Hoyes, Senior Asset Allocation Analyst. Investors should prepare for a world of higher and more volatile inflation, he warns, as services inflation remains sticky, too.

Adam Hoyes, Senior Asset Allocation Analyst at Rathbones, said:

“The increase in inflation in March captures the first effects of the conflict in the Middle East on UK households. While it may have temporarily reversed in April, inflation is still likely to be higher over the rest of 2026 than most expected at the start of the year. We think investors would be wise to take heed from recent events and prepare for a world of higher and more volatile inflation over the longer term.

“Headline UK CPI inflation reaccelerated in line with our expectations on the back of the Iran war, from 3.0% in February to 3.3% in March. The increase was, unsurprisingly, an energy price story. Energy inflation jumped from -1.0% in February to +4.9% in March, almost entirely due to higher prices at the pump.

“Fuel prices have risen further since the March data were collected. Weekly government data show the average price of petrol up around 12% in April relative to March, while diesel prices are almost 20% higher. That could add another 0.7 percentage points to headline inflation at the next data release, more than offsetting the downward pressure on inflation from the energy bill price cap, which was lowered by just under 7% in April. And the lower price cap is increasingly looking like it is only delaying the pain for households given that it is likely to rise again in July.

“To be sure, we think headline inflation will probably have eased back to around 3% again in April as hikes from this time last year in other ‘regulated’ prices, such as water bills, road tax, and rail fares drop out of the year-on-year calculation. But it’s worth recalling that before the conflict erupted many were expecting inflation to be much closer to the 2% target in April. The outlook has changed materially.

 “One crumb of comfort for rate setters at the Bank of England will be that there were few signs of higher energy costs putting upward pressure on prices elsewhere in the economy yet. Core inflation, stripping out the volatility of energy and food prices, slowed slightly from 3.2% in February to 3.1% in March (despite a 10% spike in airfares caused by the timing of Easter). We expect these so-called ‘second-round effects’ to be weaker than after the energy price shock in 2022 given how different the economic backdrop is. With a much cooler labour market, workers don’t have the same bargaining power to demand higher wages. Monetary and fiscal policy are both much less supportive than they were back then too. All else equal, that means the Bank of England has a bit more breathing room to wait and consider its response.

“Even so, we saw little evidence from today’s data to allay our concerns about the persistence of services inflation, which preceded the war. One underlying measure we track that ignores the impact of ‘regulated’ and volatile services prices has essentially not budged for almost a year now, and remains materially above its long-run pre-pandemic average. At the margin, that will make policymakers more hesitant to resume interest rate cuts.

“The outlook for inflation and interest rates beyond April remains heavily dependent on developments in the Middle East and global energy markets. The latest change shift in the US position overnight highlights the difficulty of predicting how the situation will evolve with any certainty. For us, the main takeaway from recent events has been a stronger conviction in our long-held view that the world is likely to be a more unstable place, with inflation and interest rates higher and more volatile, than we became used to in the 2010s.”