UK Inflation: A cooling trend, but no cause for celebration

British inflation eased in May, offering some relief after a volatile spring, yet the sting of rising food prices is still being felt - especially among lower-income households. According to the Office for National Statistics, annual consumer price inflation came in at 3.4%, in line with both Bank of England projections and a Reuters poll of economists. This marks a slight deceleration from April’s 3.5%, a figure now known to have been inflated by a statistical error in car tax data.

A key barometer for the Bank of England - services price inflation - also showed signs of softening, cooling to 4.7% in May from April’s 5.4%. This figure precisely matched the Bank’s expectations and came in just under consensus estimates. The primary drag came from airfares, which tumbled after a seasonal surge during April’s Easter holidays.

The correction of a tax data error also played a minor role in the month-on-month inflation deceleration. Though the flawed April data was not retroactively amended, the corrected figures were reflected in May’s calculations.

Market calm before the policy storm

Despite the cooling data, few expect a shift in monetary policy when the Bank of England announces its June rate decision. As of Tuesday, markets priced in an 87% chance of rates being held steady. The BoE last adjusted rates on 8 May, opting for a cautious 0.25 percentage-point cut to 4.25% amid a split vote. Two members favoured a more aggressive cut, while two - including Chief Economist Huw Pill - voted to hold, with Pill indicating his stance was a "skip" rather than a definitive halt to cuts.

Still, the Bank faces a delicate balancing act. Inflation in essentials - especially food, up 4.4% year-on-year in May - remains painful. Utilities and employer tax hikes in April added to the mix, nudging inflation up from 2.6% in March. Now, with oil prices on the rise again following the latest Iran-Israel flare-up, downside risks to inflation could quickly shift to upside threats.

Source: The Office for National Statistics

Inflationary risks linger, voices diverge

While the Bank’s official forecast sees inflation peaking at 3.7% later this year, some economists suspect April may have been the high watermark. Yet voices within the BoE remain divided. Some dissenters argue that the assumption inflation will fade without lingering effects may be too optimistic. Pill himself has warned against rushing interest rate cuts, citing persistent wage pressures.

In the markets, sterling nudged slightly higher against the dollar following the inflation data - an acknowledgment, perhaps, of the enduring uncertainty. Inflation may have slowed, but the path forward remains anything but predictable.