Inflation dipped in April thanks to favourable base effects from last year’s large, regulated price and tax hikes as well as measures taken to cut inflation at the last Budget which took effect in April. Inflation is likely to stabilise around this level before jumping higher in July as Ofgem hikes the energy price cap in response to higher gas prices. Weaker-than-expected inflation, coupled with yesterday’s weak labour market report means that the MPC (Monetary Policy Committee) will almost certainly stay on hold in June and likely for the whole year, unless energy prices rise much further.

Household utilities drive inflation slowdown

Inflation slowed from 3.3% to 2.8% in April. This was driven by more favourable base effects due to last year’s swathe of regulated price and tax hikes dropping out of the annual comparison.

Indeed, household utilities were the main driver of this slowdown, with household energy bills inflation slowing from 5.0% to -5.7%. There were two reasons for this. First, a big hike to the cap in April 2025 fell out of the annual comparison. Second, the government measures from the Budget to cut £150 off the typical household bill took effect. Water supply inflation also slowed sharply from 26.2% to 7.3%, as last year’s huge hikes to water bills fell out of the annual comparison, which means that household utility bills lopped a total of 56bps off headline inflation.

On the tax side of things, last year’s huge hike to vehicle excise duty (VED) also fell out of the annual comparison, which dragged miscellaneous transport services inflation down to -3.4% from 11.8%, but VED will add 0.1 percentage points to inflation in May as the ONS over-estimated the rise in April 2025 and corrected this the following month, which will create an unfavourable base effect in the next data release.

Elsewhere, the early Easter meant that airfares inflation collapsed from 14.5% to -13.2%, knocking 14bps off inflation and package holidays inflation knocked another 13bps. Much of this will unwind in the coming months as we enter the summer period and airfares inflation rises sharply later this year as higher jet fuel costs make their way through to fares.

However, much of the broad-based slowdown in inflation was offset by fuel prices. Transport fuel inflation rose from 4.9% to 23%, which added almost 0.5 percentage points to inflation. All told, if not for the Iran crisis pushing up oil prices, then inflation would have been within touching distance of 2.0% in April.

Dovish inflation print will keep MPC on hold

Inflation coming in below consensus in April, combined with yesterday’s weak labour market data, means that the MPC will almost certainly hold rates in June despite elevated energy prices.

Admittedly, the MPC would normally ‘look-through’ the sharp downwards correction in services inflation to 3.2% from 4.5% given that it was driven by Easter effects, regulated prices, and last year’s tax hikes which aren’t reflective of underlying inflationary pressures. However, we estimate that the MPC’s own measure of underlying services inflation, which strips out those components, slowed to 3.8% from 4.2%, the weakest since the start of 2022. This supports the doves’ view — those MPC members who favour keeping interest rates lower — that the economy is weak enough to bring domestically generated inflation to heel even if energy prices push up the headline inflation figures.

Further ahead, inflation will stay around 3.0% until July when it will rise back towards 3.5% as Ofgem hikes the energy price cap by around 13% to reflect higher wholesale gas prices due to the conflict in Iran. Inflation will then continue to trend up over the rest of the year as higher energy prices make their way through supply chains, higher agricultural prices and second-round effects start to be reflected in consumer prices.

That said, the weak labour market, slower pay growth and tightening financial conditions should be enough to keep second-round effects contained and prevent a wage-price spiral - where workers bid up wages in response to inflation, which firms then respond to by raising prices even more. This is why we see inflation peaking below 4.0% later this year. Therefore, it’s not clear to us that the MPC needs to aggressively hike interest rates to control inflation. Any tightening cycle, if it comes, will be short and shallow.

Ultimately, April’s drop in inflation is temporary; it will peak above 3.5% later this year. At this level, the MPC will be able to stay on hold as they balance a weak economy with elevated inflation, but the risk is that a prolonged closure of the Strait of Hormuz pushes energy prices up even further at which point the MPC would probably need to hike. In any case, any hiking cycle is likely to be brief as focus would quickly shift back towards growth as weaker real household incomes weigh on consumption and inflation falls rapidly in the second half of 2027.

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