UK inflation hits Bank of England’s 2% target in May

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Inflation has hit the UK’s 2 per cent target for the first time in three years, delivering a fillip to Prime Minister Rishi Sunak as he seeks to turn around his struggling election campaign.

The figure means consumer prices inflation has dropped to 2 per cent ahead of the US and Eurozone, in a milestone following the worst inflationary upsurge in a generation. The Bank of England last hit its 2 per cent inflation target in July 2021.

The Office for National Statistics figure for CPI growth in May was in line with a forecast of economists polled by Reuters and down from April’s rate of 2.3 per cent, driven lower by food and non-alcoholic beverages, recreation and furniture prices.

However, the latest reading showed a smaller retreat in services inflation than economists had forecast. It dropped to 5.7 per cent in May, compared with 5.9 per cent previously. Core inflation, which strips out food and energy, fell to 3.5 per cent in May 2024, down from 3.9 per cent in April but still at an elevated level.

Sterling rose 0.15 per cent to $1.2725 after the announcement.

“Headline inflation is at target, but the war on inflation isn’t won yet,” said Tomasz Wieladek, an economist at T Rowe Price. “The strong level of services inflation this morning suggests that inflation is not yet coming down in a sustainable fashion.”

Sunak, who called Britain’s July 4 election the day the April figures were published, hailed the figures on LBC radio as “very good news, because the last two years have been really tough for everybody”. But his Conservative party remains about 20 points behind the opposition Labour party in the polls.

The BoE’s Monetary Policy Committee is due to set interest rates on Thursday, with analysts widely expecting it to keep the benchmark rate at its 16-year high of 5.25 per cent.

Investors on Wednesday lowered their bets on the first quarter-point rate cut being delivered by the BoE’s August meeting to one in three, from a 45 per cent chance immediately ahead of the inflation figure being published.

While the first rate cut remains fully priced by November, traders now place a probability of about 75 per cent that a second 0.25 percentage point rate cut will be delivered this year, down from 95 per cent when markets closed on Tuesday. 

The market moves were driven by the slow progress in getting services inflation down. The MPC is closely watching the gauge as a critical indicator of domestic price pressures as the global shocks that drove up import prices fade.

Senior BoE officials have suggested that if services inflation retreats in line with the central bank’s forecasts they should be in a position to cut rates this year. But May’s reading was above the 5.5 per cent rate predicted by analysts polled by Reuters, and services and core inflation rates remain higher than the equivalent readings in the eurozone.

The UK’s strong services inflation in May was driven by high growth in airfares, accommodation and communication prices. Rob Wood, UK economist at Pantheon Macroeconomics, said the persistent strength of services inflation, coupled with strong wage growth, meant an August rate cut was a “long shot”. 

May’s drop in headline CPI inflation to 2 per cent might prove fleeting, economists warned, as downward pressures from energy prices receded. The BoE, at its most recent meeting, predicted CPI inflation would begin to trend higher later this year, heading towards 2.6 per cent in the final quarter. 

“We expect to see inflation rebound somewhat from June onwards,” said Paula Bejarano Carbo, an economist at the National Institute of Economic and Social Research. “Given that today’s data indicate that core inflation remains elevated, this rebound might be sharper than projected.”

The Conservatives and Labour sparred over the figures as they campaigned. “I know that we’ve had lots of shocks, inflation putting up people’s bills,” said Sunak.

“But we’ve stuck to a plan, taking action that wasn’t always easy but we got there. Inflation is back to target and that means people will start to feel the benefits and ease some of the burdens on the cost of living.”

Rachel Reeves, Labour’s shadow chancellor, said the lower headline inflation figure was welcome, but that households were still struggling. The overall level of prices remains 20 per cent higher than this time in 2021, when inflation was beginning to take off.

“Unlike Conservative ministers, I’m not going to claim that everything is all fine and that the cost of living crisis is over because I know that the pressures on family finances are still acute,” she told BBC Radio 4’s Today programme.

Additional reporting by Lucy Fisher and Jim Pickard in London