UK inflation was 3.4% in May, ONS says

UK inflation fell to 3.4% in May, matching expectations from both a Reuters poll and the Bank of England's (BoE) projections, following an upward revision to April's figure due to a car tax data error. Economists and investors anticipate the BoE will maintain current interest rates at its June meeting, with market pricing indicating an 87% probability of no change this week and two 0.25 percentage-point cuts priced in by year-end; however, rising oil prices due to the Iran-Israel conflict and disagreements among BoE officials regarding the persistence of inflationary pressures create uncertainty around the future monetary policy path.

Analysis

British inflation registered an annual rate of 3.4% in May, aligning with both economist polls and the Bank of England's (BoE) own projections. This figure represents a slight moderation from April's rate, which the Office for National Statistics (ONS) later acknowledged was effectively 3.4% after correcting for a car tax data error that had initially led to a published figure of 3.5% for April, though the official April statistic was not amended. Despite this alignment with forecasts, the BoE is widely expected to maintain current interest rates at its upcoming June policy meeting, with market pricing on Tuesday indicating an 87% probability of such an outcome. The rise in inflation from 2.6% in March to 3.4% in April was attributed to increases in gas, electricity, and water prices, alongside higher taxes on employers. A significant upside risk to future inflation is the potential for increased oil prices stemming from the Iran-Israel conflict. Internally, the BoE shows divergent views on inflation's persistence; Chief Economist Huw Pill recently indicated that the anticipated pace of interest rate cuts was too rapid considering ongoing strong wage pressures, though he characterized his May vote to hold borrowing costs as a temporary "skip" rather than a definitive halt to future easing. The BoE's May forecast projects inflation to peak around 3.7% later this year, although some economists posit that April might have been the high point, contingent on geopolitical developments. The central bank had previously reduced rates by 0.25 percentage points to 4.25% on May 8 following a three-way split vote, and markets are currently pricing in two additional 0.25 percentage-point cuts by the end of the year.

Key Decisions for Investors

• Investors should closely monitor the Bank of England's upcoming policy communications for nuanced signals regarding the future trajectory of interest rates, particularly given the internal disagreements on inflation persistence and Huw Pill's cautious stance on the pace of easing despite May's inflation figure meeting expectations.
• The geopolitical situation, specifically the Iran-Israel conflict and its potential to elevate oil prices, presents a material upside risk to UK inflation and should be factored into portfolio risk assessments, potentially warranting consideration of hedges against renewed inflationary pressures.
• While financial markets have priced in two 0.25 percentage-point rate cuts by year-end, investors should maintain a degree of caution regarding the actual timing and magnitude of monetary easing, as BoE decisions will remain highly data-dependent and sensitive to evolving wage pressures and the broader inflation outlook.