Inflation Hits Bank of England 2 Per Cent Target in May

Main points

• Today’s ONS figures indicate that annual CPI inflation was 2.0 per cent in May, falling from 2.3 per cent in April. This figure reflects upward contributions, such as those from transport, being offset by downward contributions from the majority of other item categories, particularly food and alcoholic beverages.
• While the fall in the annual CPI inflation rate to the Bank of England target in May is positive news, inflation will most likely rise again in in the second half of this year due to base effects. It is important to keep an eye on month-on-month inflation figures (‘new’ inflation) to determine to what extent we will see inflation rebound in the second half of 2024. In fact, the fall in May was consistent with my colleague Huw Dixon’s projection in his blog last month, due to higher than projected month-on-month inflation. So, even though headline CPI inflation reached 2.0 per cent, we’re not out of the woods yet.
• Though indicators of underlying inflationary pressures all fell on the month, some remain high. Today’s data show that core inflation remained elevated at 3.5 per cent, as did services inflation at 5.7 per cent. Given last week’s elevated wage growth data, services inflation may remain elevated in the near-term, posing an upwards risk to headline inflation.
• However, it is encouraging that NIESR’s trimmed-mean inflation measure (which excludes 5 per cent of the highest and lowest price changes to eliminate volatility) fell to 2.0 per cent, reaching this rate for the first time in nearly three years. This indicates that the fall in headline inflation is not driven by extreme price changes (e.g. energy price drops) but rather, reflects the average weighted price change in the basket – which is a good development.
• Altogether, we expect the Bank of England to exercise caution at its meeting tomorrow and hold interest rates, due to the presence of upside risks from still-strong services inflation.

“Annual CPI inflation has fallen to the Bank of England’s 2 per cent target for the first time since July 2021. While this is positive news, we expect to see inflation rebound somewhat from June onwards. Given that today’s data indicate that core inflation remains elevated, this rebound might be sharper than projected. As a result, we expect the MPC to exert caution at its upcoming meeting and hold interest rates, despite today’s encouraging fall in the headline rate.”

Paula Bejarano Carbo, Economist

For a breakdown of what inflation is and how it is calculated, read our blog post here.