The latest inflation report from the ONS has been published this morning, revealing that UK headline inflation has hit the Bank of England’s 2% target for the first time in almost three years.
This won’t come as a surprise however, as the downward trend in inflation had been widely anticpated. Food prices are the main trigger behind today’s data, although food prices generally are still 25% higher than at the start of 2022.
The eyes of market watchers and investment managers are now set on the Bank of England’s Monetary Policy Committee (MPC) as they gather data ahead of their next decision on UK interest rates at their meeting tomorrow. The consensus is that we are very unlikely to see a cut tomorrow and even a cut in August remains in question, with the direction of underlying core inflation likely to be at the centre of decisions. There’s also the small matter of a general election just weeks away, giving these decisions more political significance than usual.
Investment and economics experts have been sharing their reactions with us to today’s positive news on inflation as well as their expectations for what it might mean for the chances and timing of interest rate cuts.
Lindsay James, investment strategist at Quilter Investors:
“After a long and arduous period, UK inflation has finally returned to the coveted 2% target set by the Bank of England. Given inflation peaked at 11% two years ago, this is a big occasion for a UK economy that appeared blighted by inflation worse than comparable peers. That said, it is possible this joy will be short-lived. Much of the fall in recent months has been driven by the energy price cap, as well as food prices, which will be a diminishing factor in future months and so we expect inflation to go up again later this year and settle into a trajectory between 2% and 3%.
“Furthermore, this is not necessarily job done and victory declared for the Bank of England. The cost of living crisis persists and with wage inflation beginning to slow and prices in many areas of the economy still increasing faster than the headline rate, many won’t feel better off purely because inflation has hit 2%. This milestone being reached also does not mean a rate cut is coming tomorrow – much to the chagrin of the Conservative party. Sticky core inflation, which strips out volatile food and energy prices, seems likely to continue giving the BoE pause for thought. As such, the tail end of the summer, by which time wage inflation looks likely to further ease, seems far more likely timing for the first rate cut and the beginning of some relief for consumers and businesses.”
Andrew Summers, Chief Investment Officer at Omnis Investments, said:
“Seeing inflation back around the Bank of England’s target is welcome news, but the UK is not out of the inflation woods yet. This will probably be the lowest inflation level for this year, with small increases more likely as we approach 2025. In addition, service sector inflation is still too high for comfort albeit the trend is in the right direction.
“Nevertheless, a lot of progress has been made even if the path forward will be bumpy. This should still be enough for the Bank to cut rates a couple of times before the year is out, starting probably in August.”
Jeremy Batstone-Carr, European Strategist, Raymond James Investment Services, said:
“This morning’s data has confirmed that inflation has at last dropped back to the Bank of England’s 2% target for the first time since July 2021. Today’s outcome demonstrates that aggressive rate hikes have brought headline prices into check, without dampening economic activity too severely.
“Much of the drop in today’s inflation data is the consequence of abnormally large price increases from spring 2023 dropping out of the annual calculation. Nevertheless, the slower-paced increase in food prices will be welcomed by households.
“Underlying price pressures, which the rate-setters take most seriously, are continuing to abate more slowly given persistent strength in services inflation. Whilst the dip from April is encouraging, the fact that services companies are continuing to pass higher costs to customers may weigh on tomorrow’s much-anticipated rate decision.
“We won’t have long to wait to find out whether today’s data is sufficient to tip the scales in favour of a rate cut, or whether the central bank’s carefully nurtured independence might preclude any policy adjustment just two weeks away from the general election.”
Luke Bartholomew, Deputy Chief Economist, abrdn, said:
“The fall of headline inflation back to target was expected, but will still come as extremely welcome news to the Bank of England. The big question now is whether underlying inflation pressures in the economy are consistent with inflation staying around 2% in the medium term, or whether inflation will start to edge higher again once favourable base effects fade.
“On that front, there is still evidence of residual stickiness in services inflation, reflecting the strength of wage growth recently. That is why an interest rate cut tomorrow is still very unlikely. But we think the Bank’s communication tomorrow will set out a path for a cut in August, which is now looking increasingly likely.”
Zara Nokes, Global Market Analyst at J.P. Morgan Asset Management (JPMAM), said:
“Inflation may be back at 2% but it might not be there for long. Today’s inflation news puts the final nail in the coffin for any hopes of a rate cut from the Bank of England tomorrow. After a string of upside surprises in the recent wage growth and inflation data, today’s print shows that, once again, services inflation is still running too hot.
“Services inflation came in at 5.7% year on year, significantly above the Bank of England’s latest projection of 5.3%. If this stickiness in domestic price pressures continues, alongside ongoing resilience in economic activity, an August rate cut could well be off the table too.”
Daniele Antonucci, Chief Investment Officer at Quintet Private Bank (parent of Brown Shipley), said:
We’ve been saying for a while that UK inflation was on course to hit the Bank of England inflation target sooner rather than later. Today’s figures put headline inflation precisely at 2%, from a peak of over 11% in October 2022. Of course, the Bank would want to see more evidence that this isn’t just a blip, and we think it will.
The reduction in the energy price cap is contributing substantially to lower inflation rates. Ofgem, the regulator, has already announced a further cut in the cap for Q3. All of this points to a first quarter-percent rate cut in August. After that, we expect at least an extra cut this year, and then a series of further rate reductions to bring Bank rate down from its current 5.25% to around three and a quarter percent at end-2025.
Obviously, there’s also some probability of a June cut. But core inflation, which strips out volatile components such as energy and food and is currently at 3.5%, is still too high to make a strong case for an immediate cut.
In particular, the high level of services inflation suggests caution in extrapolating too much from the figures released today. This is an indicator that the Bank of England continues to watch with particular interest. By and large, the slowing in this key component has been relatively gradual, which is another reason to project moderate rate cuts, rather than sharp and frontloaded ones.“
James Lynch, fixed income investment manager at Aegon Asset Management, said:
“At the start of 2023 with inflation running over 10% it seemed like a gargantuan task to return inflation back to 2% target. Back then if the BoE was told it would get to the magical 2% number one day before its MPC meeting with interest rates at 5.25%, it would have been very certain it would cutting rates on the 20th June 2024.
“However, that now seems very unlikely. Indeed, even a move at the following meeting in August hangs in the balance. This is because the underlying mix of the inflation basket does not give it much comfort that this return to 2% target is sustainable. Goods inflation is in deflation at -1.3%% while services is 5.7%. The BoE has stated it believes services is a better gauge of underlying inflation and 5.7% is 0.4% above its forecast for this print.
“While it is welcome news that inflation has been tamed, we might have to wait a little longer for the BoE to be comfortable to reduce interest rates accordingly.”
Isabel Albarran, Investment Officer at Close Brothers Asset Management, said:
“While today’s fall in CPI to the Bank of England’s 2% target marks a long awaited, welcome milestone in the UK’s fight against inflation, we are not expecting any change in the MPC’s rate cut stance tomorrow. Instead, with services inflation continuing to prove stubborn, we expect rates to remain at 5.25%.
“That said, a future cut may not be far off. While the futures market has now pushed out its prediction for the first cut to November, we wouldn’t rule out a September cut just yet. However, it all depends on how the data pans out. While today’s on-target CPI print and the recent rise in the unemployment rate are promising, activity is reviving and inflation is likely to climb higher towards the end of the year, which may undermine the case for cuts.
“However, as the ECB’s recent move illustrates, policy makers can cut rates but still leave policy restrictive. In the short term though, we are fairly certain a cut tomorrow is not on the table.”
Yvan Mamalet, Senior Market Strategist, SG Kleinwort Hambros, said:
“The UK inflation report today shows that inflation continued to moderate, coming in at +2.0% year-on-year. However, the services component has been problematic and remains elevated, at +5.7% year-on-year, making it very unlikely that the Bank of England will cut rates at their meeting tomorrow. A rate cut in August remains possible.
“Looking deeper into the detail, the main downward pressures came from food prices, energy prices and non-energy industrial goods inflation (first time in negative territory since 2016 – due to clothing and household equipment mostly). Conversely, within services inflation, rents, transports and to a lesser extent communication price increases explain the bulk of the still elevated figures.
“Regarding tomorrow’s BoE meeting, this data seems not only too late but also not offering enough evidence that domestic inflationary pressures are softening (especially as last week’s wage data remained strong). However, by the time of the early August meeting, the BoE may have enough confidence that inflation is well-entrenched at around target (even though a rebound later this year seems likely) to start cutting rate. We continue to expect two cuts this year.”
Tom Stevenson, Investment Director at Fidelity International, said:
“The return of inflation to the Bank of England’s 2% target is not the end of the cost-of-living crisis but it may mean we are through the worst. The drop in the headline rate of inflation to 2.0% is welcome news for the Prime Minister, Rishi Sunak, just a couple of weeks before the general election. It will be highlighted by the government as evidence that the economy has stabilised, despite growth stagnating in April.
“This is the first month in nearly three years that inflation has been at or below the official target, having peaked at a 40-year high of 11.1% in October 2022. The main driver was food prices, which fell in the month, offset by rising fuel costs.
“What is less likely is that the Bank of England will view today’s reading as a prompt to cut interest rates from their 16-year high of 5.25% tomorrow. Under the surface, the rate of services inflation, at 5.7%, remains a concern. Core inflation (excluding energy, food, alcohol and tobacco) eased to 3.5% from 3.9% but also remains well ahead of the Bank’s target.
“The Bank is focused on wages, which continue to grow faster than the headline rate of inflation. Another split decision is likely, with a majority expected to vote to hold the bank rate steady for another month. Although the Bank is independent of the government, a rate cut so close to the election would be controversial. Having paused speeches and other communications during the election campaign, the monetary policy committee would not be able to explain why they had cut rates at this week’s meeting.”
Commenting on UK headline inflation reaching the Bank of England’s 2% target today, Ross Barr, Senior Multi-Asset Strategist, Cardano, said: “While underneath the hood there remains a lot of stickiness in certain components of core CPI, the sequential return to a more normalised rate of inflation continues.
“Excluding shelter from US CPI, UK CPI is the lowest alongside the US in May (see Chart 1). On the surface, this is encouraging for UK rates on a relative basis as it confirms that some of the idiosyncratic factors that attached a higher risk premium to the UK bond market continue to fade. However, the drivers of today’s fall in headline – goods and food – were already anticipated by the market and it was the stickier components that were of more interest. On this, Services CPI is one of the BoE’s Monetary Policy Committee’s key measures to gauge the persistence of inflation. This only slowed to 5.7% from 5.9% (after falling only marginally in April vs expectations and the May print coming in over market expectations of 5.5%). The BoE’s own forecasts were at 5.3% for May, so this print challenges their desire to cut rates.
“A lot of services measures are still well above month-on-month long-term averages and will also need to come down more sustainably to satisfy the BoE (see Chart 2). However, the fall in recreation services month-on-month (0.7% to 0.3%) – the largest weight within the services category and arguably most exposed to post-pandemic impacts – is welcome. Private sector regular pay growth fell last week as well – the increase in the National Living Wage hasn’t had as a material impact as feared so far. The direction of disinflation in the services sector is slow and fairly stubborn but we think the direction remains intact. The continued fall in energy costs is also a potential catalyst for lower overall prices as we go into the second half of this year.
“Overall, we still expect underlying inflationary pressures to ease sequentially this year and the BoE to start cutting rates from August.”
