UK inflation unexpectedly stays at 2.8% with higher transport costs offset by slower food price rises – business live | Business

Economists reckon UK inflation will peak below 4% in the coming months.

James Smith, developed markets economist at ING, expects a return to interest rate cuts next year.

“What’s striking about these latest figures is just how benign food inflation is right now,” he said.

It’s a key reason why headline CPI unexpectedly stayed at 2.8%, despite upward pressure from air fares and a quirk related to road tax. Food prices fell in May relative to April, a trend we’ve also seen in the eurozone and Eastern Europe. If anything, the latest producer price data suggests food inflation will continue to fall sharply over the next couple of months. That will gradually change, but it’s a reminder that the energy price spike is unlikely to reach its peak impact on food inflation until the first quarter of next year.

In general, it’s too early to see much impact from the Middle East crisis beyond fuel prices. Services inflation is bouncing around, partly due to the timing of Easter this year, but the Bank of England’s preferred gauge of “core services” – which excludes volatile and indexed categories – has been more stable just below 4%. The BoE’s own “Decision Maker Panel” of CFOs points to services inflation staying around current levels through the summer.

We’re still sceptical that the Middle East crisis will generate the widespread “second round” effects that policymakers fear. Evidence from twelve months ago, when a National Insurance (payroll tax) and minimum wage hike failed to do much to the inflation picture, suggests corporate pricing power is considerably weaker than it was during the last energy shock four years ago.

The same is true of worker bargaining power. Wage growth has been exceptionally weak over the past few months.

All of that suggests inflation is likely to stay below 4% – a key line in the sand for the BoE. It put a lot of emphasis last summer on analysis showing second round effects were more likely when inflation exceeded that level. A 13% rise in household energy bills this July is likely to take inflation towards 3.5% by September, but on current prices, we’re likely to see a 7% fall in those bills come October. That’s because natural gas futures for delivery in 6-12 months are at pre-war levels – and they are a key determinant of the energy regulator’s price cap.

Barring the Iran deal falling apart and oil prices spiking back above $100 a barrel – and natural gas costs soaring too – we think the Bank of England is set for a prolonged pause. We expect a 7-2 vote in favour of ‘no change’ tomorrow. We expect a return to rate cuts in 2027.