Inflation remained unchanged in May as rebounding airfares were offset by weak food and core goods inflation. Even with the peace deal between the US and Iran helping to bring down energy prices, we still expect inflation to rise to 3.5% as higher energy prices work their way through supply chains. Therefore, we expect the Monetary Policy Committee (MPC) to stay on hold throughout 2026 before beginning to cut rates again next year.

CPI stable in May

Inflation held steady at 2.8% in May, as rebounding airfares were offset by slowing food and core goods inflation.

The big driver of inflation in May came from transport inflation jumping from 4.5% to 6.8% in May. Much of this was due to airfares surging from –13.2% to +0.9% this month which added 7bps to headline inflation as the impact of the early-Easter, which weighed on airfares in April, washed out. Airfares are sampled between one, three and six months in advance depending on flight distance, which means we are yet to see much impact from higher jet fuel prices on flights. That said, we continue to expect airfares to trend up in the coming months as higher fuel prices feed through to airfares.

Fuel inflation also rose from 23% to 24.6% adding another 4bps to headline Consumer Prices Index (CPI). Lower oil prices mean that fuel inflation will now fall sharply over the summer months. Meanwhile, a base effect from the ONS correcting its estimate of Vehicle Excise Duty (VED) last year, mechanically added 10bps to inflation.

This was offset by slowing core goods inflation which knocked 11bps off the headline rate. Indeed, much of the weakness here was driven by clothing and household goods which could be a sign of weak demand as household’s held off on spending due to the uncertainty created by the war in Iran.

Similarly, food inflation also slowed from 3.0% to 2.2%, with prices falling on the month, which lopped another 9bps off inflation. Food inflation will surely rebound with the UN’s measure of agricultural commodity price inflation rising from –0.9% before the conflict in Iran to 2.9% in May.

All told, inflation surprised to the downside in May, but we expect much of the downside surprise in food and core goods to unwind in the coming months as higher energy prices and supply chain disruption push up prices.

Dovish inflation print confirms MPC on hold tomorrow

Inflation coming in below the consensus for 3.0% in May, combined with news of a ceasefire deal that has seen oil and gas fall back sharply means the MPC will almost certainly stay on hold this week and probably for the rest of this year.

In fact, the recent drop in oil prices means that inflation will now be broadly stable in July, instead of jumping up as previously expected as falling pump prices will offset much of the upwards impact from Ofgem’s 13% hike to the energy price cap.

That said, inflation will still peak around 3.5% later this year for three reasons. First, food inflation will rebound as higher fertiliser, and diesel prices make their way through supply chains. Similarly, leading indicators suggest that core inflation will pick up sharply later this year, even if price pressures from energy costs ease in the coming months as firms pass on higher transportation costs to consumers. Third, even if the fragile peace accord in the Middle East holds, it will take weeks or months for shipping flows to return to normal which means that supply chain disruption may persist well into the second half of this year.

However, the weak labour market 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. Indeed, we see private sector pay gains averaging 3.1% this year and is a key reason inflation is likely to peak at just 3.5%, instead of surging to double digits as it did in 2022.

In any case, energy prices will remain above pre-war levels for the foreseeable as damage to energy infrastructure and a higher risk premium keep prices elevated, preventing inflation from falling back to target until next year.

Ultimately, May’s weak inflation data, a continued weakening in the labour market and lower energy prices means that risk of the MPC hiking rates later this year are now much lower. That said, we still think the Committee will be on hold, inflation will rise to 3.5% with risks still tilted to the upside and we were already concerned about how well-anchored inflation expectations were before the crisis given that inflation has only been at or below target four times in the last 60 months of inflation data. That means it won’t be until 2027 when the MPC can start cutting rates again as focus shifts back towards the weak labour market and subdued growth.

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