Inflation Stays On Hold, But Relief Will Be Short-Lived

Kevin Brown

The data suggests the recent energy shock hasn’t fed through as forcefully as feared, giving the Bank of England more room to look through immediate inflationary pressure from the Iran conflict.

At tomorrow’s meeting, the Bank will likely still need to tread carefully. The economy contracted in April, hiring intentions remain weak and households are highly price sensitive, so raising rates could add pressure while lacking the power to lower global energy prices.

Hopefully easing pressures in the Middle East should dampen inflation concerns and give policymakers more time to assess whether this is a short-term shock. That points to a hold, while an unchanged reading makes it harder to argue for an immediate rate rise.

For households, this is encouraging, but inflation doesn’t need to be rising for the cost-of-living squeeze to remain painful. The practical response for many will be to review savings rates, energy tariffs, mortgage costs and everyday spending, while considering whether longer-term money could work harder through investing.

Alpesh Paleja

Inflation was widely expected to pick up in May, so the latest data comes as a welcome surprise. But this is likely to be the calm before the storm, with price pressures set to see a pronounced rise over the coming months. The direct contribution from higher energy costs is set to increase – particularly with households' energy bills rising from June – and this is likely to feed through to other parts of the inflation basket.

That remains true despite the deal between the US and Iran to extend the ceasefire and reopen the Strait of Hormuz. Details of the agreement have yet to be finalised, and energy flows are unlikely to resume immediately, meaning it does little to alter the near-term outlook. Global energy prices also remain above their pre-conflict levels, and the lagged pass-through via supply chains means inflation is still likely to rise further over the coming months.

However, the deal does reduce the risk of the more severe inflation scenarios that had been feared if the conflict escalated further or energy infrastructure suffered additional damage. While households are still likely to face a prolonged squeeze on living standards, the outlook is now less challenging than it appeared only a few weeks ago.

Anna Leach

Inflation has once again come in lower than expected in May, as rising fuel inflation was offset by lower rates in other categories, like food, clothing and recreation and culture. Some recent policy measures will also help push down on inflationary pressures for households in the coming months, including temporary VAT reductions on leisure activities and the extension of the fuel duty freeze.

Today’s steady inflation rate should be more than enough for the Bank of England to keep rates on hold this month. But even a swift end to the Iran conflict will leave global energy supplies disrupted and prices elevated for a considerable period, driving inflation towards 4% by the end of the year. To minimise the risk that inflation becomes embedded, government needs to think more deeply about the drivers of price increases. Rising energy, tax and employment costs affecting businesses need addressing if broader inflationary pressures are to be minimised.