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UK Inflation Hits Bank of England’s 2% Target in May 2024

Inflation slow to 2%

UK Inflation Hits Bank of England’s 2% Target in May 2024: A Surprising Turn of Events

Inflation in the UK has finally hit the Bank of England’s (BoE) target of 2% in May, marking the first time in three years that this milestone has been achieved. Prime Minister Rishi Sunak, amid his challenging election campaign, received this news with open arms, labelling it as “very good news.”*

A Brief History of Inflation Woes

The last time the BoE saw this 2% target was in July 2021. The recent data from the Office for National Statistics aligns with economists’ forecasts and now places UK inflation below that of the US and the Eurozone. Despite this promising figure, the rising prices in the services sector have kept investors cautious about future interest rate cuts.

Inflation chart

Market Reactions and Future Predictions

The futures market, once hopeful for a quarter-point rate cut by August, now shows less optimism, with the probability dropping to less than a third from the previous 45%. Tomasz Wieladek, an economist at T Rowe Price, emphasized that the battle against inflation is far from over, especially with persistent service price hikes.

A Closer Look at the Numbers

In May, consumer price inflation dipped from April’s 2.3%, thanks to slower price increases in food, non-alcoholic beverages, and furniture. While Sunak celebrated these numbers, services and core inflation remain stubbornly high compared to the Eurozone. The BoE’s Monetary Policy Committee is expected to maintain the current rate of 5.25%.

Services inflation stood at 5.7% in May, down slightly from 5.9% in April, but still above forecasts. This minor drop was driven by higher costs in airfares and accommodation. Rob Wood, an economist at Pantheon Macroeconomics, suggested that a rate cut in August remains unlikely due to the strong wage growth and persistent service inflation.

Core Inflation and Long-term Outlook

Core inflation, excluding food and energy prices, fell to 3.5% in May from 3.9% in April. However, economists warn that this reduction might be temporary. The BoE projects a rise in CPI inflation later this year, potentially reaching 2.6% by the final quarter. Paula Bejarano Carbo from the National Institute of Economic and Social Research indicated that the rebound might be sharper than anticipated due to high core inflation.

Political Sparring Over Economic Performance

The latest inflation figures have fueled political debates, with Sunak and the Conservatives claiming credit for economic stability and the potential for tax cuts. Meanwhile, Rachel Reeves, Labour’s shadow chancellor, acknowledged the improvement but highlighted the ongoing struggle for households, noting a 20% price increase since 2021.

Inflation and the Election: What’s Next?

The inflation rate hitting the 2% target is certainly a milestone, but it’s not likely to change the BoE’s base rate before the upcoming election. Given the complexities of the current economic environment, the BoE is expected to hold the base rate steady at 5.25%, its highest level in 16 years. This is largely due to the persistent pressures in the services sector and the cautious stance of investors.

Sunak’s Optimism and Economic Strategy

Prime Minister Rishi Sunak has seized upon this moment as a positive indicator of his government’s economic policies. He argues that the Conservatives have managed to restore economic stability, which could pave the way for potential tax cuts. Sunak’s optimistic outlook is designed to bolster his campaign, emphasizing that his party’s strategies are working despite the challenging economic climate.

Labour’s Counterpoint

In contrast, Labour’s Rachel Reeves has pointed out that while the lower CPI rate is welcome, it does not negate the fact that households are still grappling with high prices. Since 2021, prices have surged by 20%, making the cost of living a significant concern for many UK residents. Reeves argues that more needs to be done to address these issues, beyond celebrating a single month’s data.

Potential inflation Conundrums

The Services Sector

The services sector remains a critical area of concern for economists and policymakers. Despite the overall CPI rate hitting the target, services inflation is still relatively high. This sector includes essential services such as healthcare, education, and transportation, which are critical to the everyday lives of UK citizens. The persistent inflation in this sector suggests that underlying pressures remain, which could hinder a more sustained economic recovery.

Wage Growth and Inflation

Another significant factor influencing the BoE’s decisions is wage growth. Strong wage growth can lead to higher spending, which in turn can fuel inflation. Rob Wood of Pantheon Macroeconomics notes that the combination of strong wage growth and persistent services inflation makes an August rate cut unlikely. The BoE will need to carefully balance these factors to ensure that inflation remains under control without stifling economic growth.

The Impact on Households

For the average UK household, the battle against inflation is far from over. While a 2% CPI rate is a positive development, it does not immediately translate to relief for consumers. Many are still facing high prices for everyday goods and services, and the cost of living crisis continues to be a major issue. The high inflation rates over the past few years have eroded purchasing power, making it more challenging for families to make ends meet.

Energy Prices and Future Inflation

Energy prices have played a significant role in the recent inflation trends. The reduction in energy prices contributed to the lower CPI rate in May. However, economists warn that this impact might be temporary. As the effects of falling energy prices wear off, there is a risk that inflation could rise again. The BoE has already projected that CPI might increase towards the end of the year, potentially reaching 2.6%.

Global Context and Comparisons

In a global context, the UK’s inflation rate now sits below that of the US and the Eurozone. This is a notable shift, indicating that the UK is making progress in controlling inflation. However, this does not mean that the challenges are over. Each economy faces its own unique set of circumstances, and the UK must navigate its path carefully to maintain stability and growth.

Investor Sentiment and Economic Forecasts

Investor sentiment plays a crucial role in the economic landscape. The cautious approach by investors, in light of the persistent services inflation, suggests that there is still uncertainty about the future. The probability of interest rate cuts has decreased, reflecting the cautious optimism in the market. Economists and investors will be closely watching upcoming data to gauge the BoE’s next moves.

The Base Rate: Unlikely to Change Before the Election

Inflation and mortgages have been a hot topic over the last 2 years. The rest bite from a 16-year high base rate may not be coming just yet though. Although there have been cries to cut interest rates this month it is unlikely we will see mortgage interest rates coming down just yet. The market has seen expectations for the first cut to the base rate to not come until after the general election. We also need to remember that everything still remains extremely fragile and the data can change month to move which could see expectations change with little to no notice.

For anyone who has been sitting on the fence and waiting for rates to drop there is a real risk of failing to time the market and therefore recommended to seek expert advice at the earliest point possible.

Bank of England

Conclusion: A Milestone, But Not the End

Hitting the 2% target is a significant milestone for the UK economy. It provides a moment of respite and a sign that efforts to control CPI are yielding results. However, the underlying challenges remain. Persistent services inflation, strong wage growth, and the potential for rising inflation in the future all indicate that the journey is far from over.

Prime Minister Rishi Sunak’s government will continue to face scrutiny as it navigates these economic waters. The upcoming election adds another layer of complexity to the situation. Voters will be considering the broader economic context as they make their decisions, and both major parties will need to address these ongoing issues in their campaigns.

In the end, while May’s CPI figures bring a glimmer of hope, the UK must remain vigilant and proactive in its economic policies. The path to sustained economic stability and growth requires careful management of inflation, investment in critical sectors, and support for households facing the cost of living crisis. The next few months will be crucial in determining the trajectory of the UK economy and the success of these efforts.

*Source of Data – The Financial Times – https://www.ft.com/content/87e15930-b81d-4ce5-9e73-33e2b05548cb

**Data is correct as of 20th June 2024


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