CPI inflation: Another rate hike likely as inflation only drifting down

The smaller-than-expected fall in inflation in April to 8.7% - the Bank of England (BoE) expected 8.4% - will pile more pressure on the Monetary Policy Committee (MPC) to hike interest rates again in June. Even more concerning was the acceleration in core inflation, which excludes volatile components such as energy and food, to 6.8% from 6.2%. Admittedly, there is still another set of data to come before the next MPC meeting. But given there are only the most tentative signs that the labour market is easing and that inflation is clearly stickier than the Bank was hoping for, we are sticking with our call that rates will have to rise again in June. A 5% peak now looks even more likely. 

Food prices have probably peaked, but are proving sticky

The biggest single reason for the fall in the headline rates was a base effect associated with the large rise in household energy bills in April 2022. Prices rose by 47.5% between March and April last year. This year, bills posted a 1.2% fall reflecting the influence of the Government’s Energy Price Guarantee, which has capped the unit cost of gas and electricity since October such that the average household pays £2,500 annually. This caused electricity and gas inflation to fall from 85.6% in March to 24.3% in April.

Food inflation also fell to 19.3% from 19.6%, although this was a much smaller fall than expected.

More concerning for the MPC will be the rises in core inflation (6.2% to 6.8%) and services inflation (6.6% to 6.9%). The upside surprise appears to have come from a wide range of services prices, especially insurance premiums, which are continuing to rise very quickly.

What next?

CPI inflation will continue to fall quickly over the coming months. Tomorrow, Ofgem likely will announce that the typical household’s annualised energy bill will drop to about £2,050 in July, down 18% from the current £2,500 level. This will ensure that energy’s contribution to the headline rate falls by a further 0.8 percentage points or so in July.

Indeed, the cooling of producer price inflation, lower shipping costs and the easing of supply constraints have all pointed to a slowing of core goods inflation. That hasn’t materialised yet, but should over the rest of this year. We expect goods price inflation to fall to around 3% by the end of the year.

The policy takeaway

The guidance the BoE issued alongside its May forecast suggests it will tighten more if the data – in particular services CPI and private sector pay – surprise to the upside. Clearly that is happening, which points to another rise in interest rates in June – taking interest rates to 4.75%.

Evidence of a more sustained easing in price pressure over the summer is likely to be enough to convince the BoE that June should be its last hike of the cycle. But the stickiness of both core inflation and pay growth means that the risks to our forecast are tilted to the upside — a 5% handle on the BoE’s policy rate is becoming increasingly likely.