Benign UK food inflation keeps CPI below 3%
The UK is the latest country to experience remarkably benign food inflation in May, despite the Middle East crisis which threatens to push up costs later this year. If energy prices stay where they are, we're likely to see inflation peak around 3.5% in September. We don't think that meets the bar for rate hikes.
May’s lower-than-expected UK inflation figures are the latest data point questioning the need for rate hikes. We see inflation peaking around 3.5% in September on current energy prices. That’s unlikely to justify a rate rise from the Bank of England.
What’s striking about these latest figures is just how benign food inflation is right now. It’s a key reason why headline CPI unexpectedly stayed at 2.8%, despite upward pressure from airfares 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 change over time as the increase in fuel and fertiliser prices will push up food costs into next winter. But given how much ink has been spilled by Bank of England officials on the role of food prices in shaping consumer inflation expectations, today's data will be welcome.
Producer prices point to lower food inflation into summer
Overall, 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 at just below 4%. The BoE’s own “Decision Maker Panel” of CFOs points to services inflation staying around current levels in the summer.
Beyond that, we’re still sceptical that the Middle East crisis will generate the widespread “second round” effects that policymakers so fear. Evidence from 12 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.
The BoE's 'core services' measure has stabilised below 4%
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 USD/bbl – 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 – and a return to rate cuts in 2027.
Author
James Smith
ING Economic and Financial Analysis
James is a Developed Market economist, with primary responsibility for coverage of the UK economy and the Bank of England. As part of the wider team in London, he also spends time looking at the US economy, the Fed, Brexit and Trump's policies.
