BofA sees August rate cut as UK inflation cools

UK inflation edged down to 3.4% in May, slightly above the 3.3% consensus but aligned with the Bank of England's forecast, while core inflation met expectations at 3.5%. Services inflation saw a more significant drop to 4.7%, below the 4.8% consensus, driven by a sharp decline in airfares, though food inflation rose to 4.4%. Bank of America anticipates the Bank of England will hold rates in June but projects a dovish pivot in the second half of the year, with rate cuts expected in August, September, and November, contingent on continued progress in domestic inflation and a looser labor market.

Analysis

UK inflation in May registered a slight deceleration to 3.4% year-over-year, marginally exceeding the consensus forecast of 3.3% but aligning with the Bank of England's (BoE) projection. Core inflation moderated to 3.5%, in line with expectations. A more pronounced decline was observed in services inflation, which fell from 5.4% to 4.7%, below the 4.8% consensus and matching the BoE's estimate, largely driven by a significant drop in airfare inflation from 16.2% to -3.9% attributed to the timing of Easter. Conversely, food inflation accelerated from 3.4% to 4.4%, potentially reflecting rising employment costs, while core goods inflation also ticked up from 1.1% to 1.6%. Energy costs continued their deflationary trend, moving from -0.9% to -1.7%. Bank of America (BofA) anticipates the BoE will maintain current interest rates at its June meeting but projects a dovish policy shift in the second half of the year. BofA forecasts rate cuts commencing in August, followed by further reductions in September and November, potentially bringing rates to 3.5%. This outlook is predicated on continued progress in managing domestic inflation, easing wage pressures, lower inflation expectations, and a softening labor market. BofA also projects headline inflation to further ease to 3.3% and services inflation to 4.5% in June, viewing April's inflation uptick as an anomaly. However, potential oil price shocks due to geopolitical developments present a notable risk to the disinflationary trajectory.

Key Decisions for Investors

• Investors should monitor upcoming Bank of England communications and subsequent inflation data, particularly services and wage growth, as these will be critical determinants for the anticipated rate cuts in the second half of the year.
• Consider positioning for a potential dovish pivot by the BoE, which could benefit rate-sensitive assets, while remaining vigilant to the uptick in food and core goods inflation which may impact specific consumer-facing sectors.
• Maintain awareness of geopolitical risks, particularly those that could lead to oil price shocks, and consider appropriate hedges if portfolio exposure to energy price volatility is significant.