The UK has “won the race” in getting headline inflation back to target, says Sanjay Raja of Deutsche Bank. The annual rate of inflation hit the Bank of England’s (BoE’s) 2% price target in May for the first time since 2021. By contrast, US and euro area inflation are running at 3.3% and 2.6% respectively.
The return to target has been helped along by falling goods prices (down an average of 1.3% over the past year) thanks to cooler food-price inflation and falling household energy tariffs. Yet the “fly in the ointment” remains stubborn price rises in the services sector, where inflation is still running at 5.7% year-on-year as high wage costs bite (average UK pay rose 6% in the year to February-April, excluding bonuses). The bad news is that UK inflation is thus unlikely to stay at 2% for long and looks likely to average 2.5% in the second half of the year.
Rate cuts are coming
Cooler inflation should open the door to interest-rate cuts, but not straightaway. Last week the BoE’s monetary policy committee again voted to hold interest rates at 5.25%. Seven committee members opted to hold, with two supporting a cut.
The minutes of the meeting marked “a significant change in tone” for the Bank, say Dearbail Jordan and Faisal Islam for the BBC. “While not a done deal,” Threadneedle Street has sent “a clear signal to the markets” that “a rate cut is now the most likely outcome at its next meeting” in August. It would thus join the European and Swiss Central Banks, which have already begun cutting rates.
At 5.7%, annual services inflation is still running at about twice the level consistent
