Inflation data has implications for interest rate policy

A spike in food and drink prices today fuelled worries that the effect of National Insurance and other wage hikes may keep inflation higher for longer and delay interest rate cuts.

Most City economists currently expect the Bank of England will next reduce borrowing costs in August, followed by another quarter point cut in November.

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No change is expected at this week’s meeting, when members of the Monetary Policy Committee (MPC) were presented with a May inflation figure in line with their projections at 3.4%.

April’s spike in bills was followed by a drop in airfares due to the timing of Easter and an easing in the rate of services inflation, which is seen as a key requirement for a rate cut.

The progress was offset by a surge in food and non-alcoholic beverage prices from 3.4% to 4.4%, the highest annual rate since February last year.

Seven food categories saw inflation in double digits, including butter at 18.2%, chocolate at 17.7% and coffee at 13.9%.

The Food and Drink Federation said this was due to significantly higher industrial energy costs compared to other nations and a surge in price of ingredients. It highlighted the example of cocoa, which has tripled in price in the last two years.

Economists also believe that selling prices are being driven by higher employment costs after April’s increase in National Insurance contributions and National Living Wage.

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Another surprise in the release concerned the rise in furniture and household goods inflation from a fall of 0.5% in April to 0.8% in May.

Capital Economics still expects that the Bank of England will cut rates by quarter percentage points twice more this year.

However, the consultancy added: “The big risk in the near term is that another bout of second-round effects on wages and inflation expectations means inflation stays above 3% for longer and causes the Bank to shift to a slower rate cutting path.”

An added complication involves recent events in the Middle East, which have left Brent Crude futures trading near to $76 a barrel in today’s session. That’s still below its 2024 average of $80 but it had been at $58.20 in early May.

Deutsche Bank believes the uncertainty is likely to reinforce the Bank’s “gradual and careful” approach to dialling down restrictive policy.

It said: “Today's data should help convince MPC members on the fence that price pressures are tracking as expected and underlying disinflation remains on track.

“But don't expect a dovish pivot just yet – more data and more accumulation of evidence that the economy is returning to a sustainable equilibrium will be needed to push the MPC into a more dovish direction.”

Bank of America expects the inflation progress to continue, forecasting a headline rate of 3.3% for June and further fall in services inflation from 4.7% to 4.5%.

It said: “We expect the BoE to be on hold tomorrow but the continued progress in domestic inflation should prompt them to hint that a summer skip to quarterly cuts is less likely.”

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The bank expects a dovish pivot in the second half of the year due to progress in domestic inflation, easing pay settlements, a looser labour market and growth weakness.

It added: “Recent geopolitical developments also increase the risks of a large and persistent oil price shock, which could cause some delays to cuts. But for now, the moves are relatively muted for it to affect the BoE's reaction function.”

For savers, Moneyfactscompare.co.uk said there are currently 1,437 accounts that beat May’s inflation rate of 3.4%. This compares with the 1,602 deals that were better than last year’s rate of 2% and none in June 2023 when the inflation reading was 8.3%