Why the Bank of England can relax about inflation?

ING anticipates a potential spike in the UK's April inflation data due to regulated price increases, but expects underlying services inflation, a key metric for the Bank of England (BoE), to fall to around 4.2% by June, below the BoE's 5% projection. This expectation is driven by easing rental pressures and slowing wage growth, potentially allowing the BoE to become more comfortable with rate cuts, possibly resuming in August with a terminal rate of 3.25%, lower than the market's forecast of 3.7%.

Analysis

ING projects that while the U.K.'s April inflation data, due May 21, may exhibit a temporary surge due to regulated price adjustments including water bills, energy, and road taxes, underlying inflationary pressures are abating. Crucially, services inflation, a key metric for the Bank of England (BoE), is anticipated by ING to decline to approximately 4.2% by June, notably below the BoE's own forecast of 5%. This outlook is underpinned by several factors: rental growth, a significant services inflation component, is showing signs of deceleration with new lease growth slowing and social housing rent increases capped below 3% (compared to nearly 8% previously), although the full CPI impact will materialize in July. Furthermore, wage growth is cooling; while annual private-sector pay growth stands at 5.6%, the three-month annualized rate has moderated to 3%, and corporate pay increase plans are becoming more modest. ING suggests these developments, despite the recent National Living Wage hike, could allow the BoE to become more comfortable with initiating rate cuts, potentially commencing in August with a quarterly cadence. ING also foresees a terminal interest rate of 3.25%, which is lower than the current market pricing of 3.7%, implying a more dovish BoE stance than anticipated by the broader market.

Key Decisions for Investors

• Investors should monitor the U.K.'s April inflation release on May 21 closely, as it has historically triggered significant market reactions and repricing of Bank of England expectations.
• Consider the potential for the Bank of England to adopt a more dovish monetary policy stance from August, should ING's forecasts for easing services inflation and moderating wage growth materialize.
• Evaluate positioning in UK fixed income markets, as ING's projection of a 3.25% terminal rate, below current market pricing of 3.7%, could present opportunities if the central bank's policy path aligns with this more dovish outlook.