CPI inflation: Stickier inflation means more cautious MPC

22 May 2024

The drop in inflation to 2.3% in April is good news for the economy, but the stickiness in services inflation makes an August rate cut more likely than a June one now. Financial markets are pricing in just a 15% chance of a rate cut in June. The bigger picture, though, is that with inflation only fractionally above the Bank of England’s (BoE) 2% target and likely to fall further over the next few months, in our view, not cutting this summer would be an unforced policy error by the BoE.

Key drivers 

Inflation dropped from 3.2% to 2.3% in April compared to expectations of a fall to 2.1%. As expected, a 12% monthly drop in energy prices was the big driver of lower inflation. Annual energy price inflation is now -27.1%. This dragged overall goods inflation down to -0.8%, meaning that goods prices are lower now than a year ago.

However, services inflation remains sticky dropping to just 5.9% from 6%, well above the expectation of 5.4%. This will be worrying for the Monetary Policy Committee (MPC) as services inflation is much more closely related to the domestic economy. Some of this was due to phone and internet firms inflation-linked price hikes. But there was also stronger inflation in all the recreation and hospitality sectors. Indeed, inflation in recreational and cultural services jumped from 5.1% to 7.1%. Accommodation services rose another 0.9% month-to-month after rocketing 3.8% in March. This component appears to be following a new seasonal pattern since the pandemic, with price hikes coming earlier in the year - in March rather than April. Even so, accommodation services prices rose 4.8% across March and April combined this year, compared to a 3.0% rise last year. We doubt that can be attributed to Easter. 

What next? 

Looking ahead, it remains likely that the headline rate of CPI inflation will continue to fall over the next few months. We expect it to be about 2.0% in May and then hover around the 2% target over the following six months. Food CPI inflation will continue converging to weaker producer output price inflation. Goods inflation will likely drop further in sympathy with global costs, and the chunky services price rises last year continue to drop out of the annual comparison, slowly lowering services inflation.

What’s more, the surprising strength in services inflation is probably at least partly due to firms passing on the massive increase in the National Minimum Wage in April - if that is the case then this may be more of a one off hit to prices than a change in the underlying inflation dynamic.

The policy takeaway 

The obvious implication from today’s data is that a June rate cut is much less likely. The MPC will still cut rates this year as inflation gradually declines, but today’s print combined with the strength of the economy in March, eliminates the urgency and supports the calls of the more cautious MPC members to take some time before easing policy. Even with the May CPI print (which the committee will get before its June meeting) likely to show a further fall in both services and in headline inflation, it now looks like the majority of the MPC will wait until August to cut rates for the first time.

However, we think delaying rate cuts beyond the summer would be a mistake. In our view, the MPC would be justified in cutting rates more aggressively than is currently priced into the market. With inflation likely to be at or around the 2% target for most of the next two years, rates are clearly well into restrictive territory and are holding back the economic recovery sorely needed by the UK.

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