UK inflation remained steady at 2.8% in May, according to the Office for National Statistics, coming in lower than economists had anticipated. The consumer prices index (CPI) held below 3%, though analysts warn of further price rises later this year.
Core and Services Inflation
Core inflation, which excludes volatile energy and food prices, stood at 2.6%. Services inflation, closely watched by Bank of England rate-setters for signs of wage pressures, rose sharply from 3.2% to 3.7%.
Grant Fitzner, chief economist at the ONS, said: "The main upward movement came from transport with airfares, vehicle taxes and petrol prices all pushing up inflation. These were offset by lower food prices, with decreases in inflation seen across a range of meat, dairy and vegetable items compared to last month as well as the cost of domestic heating oil, which fell back after climbing in recent months."
Future Inflation Outlook
Analysts suggest inflation could approach 4% later this year and into early 2027, with the Bank warning prices could surge as high as 6% in the most severe scenario. Much depends on whether the Strait of Hormuz fully reopens following the US-Iran peace agreement, and how businesses respond to the shifting economic landscape.
Paul Dales, chief UK economist at Capital Economics, forecasts inflation will climb over the coming nine months, though a recent dip in oil prices suggests it may fall short of 4%. He noted that higher energy costs "don't yet seem to be feeding into other items", as evidenced by easing food price inflation.
Business and Policy Responses
Andrew Griffith, the shadow business secretary, cautioned that rising business costs of as much as 9% "means either higher prices are coming to the high street, more firms closing with the loss of jobs, or both." Should tensions flare up once more across the Middle East, analysts caution that upward pressure on prices could intensify.
The Bank's Monetary Policy Committee faces a considerable challenge given a weakening labour market and stubbornly elevated inflation expectations. Luke Bartholomew, deputy chief economist at Aberdeen, said: "With inflation coming in softer than expected again, the pressure on the Bank of England to hike rates this year will continue to fade, although there may still be a couple of policymakers who vote for a rate increase tomorrow. Despite energy prices having fallen recently, there is more inflationary pressure to come for the UK."
Interest Rate Scenarios
The Bank is expected to lean on its scenario modelling, with two outcomes from the Iran conflict suggesting that interest rates would not need to rise. In the worst-case scenario, however, interest rates could surge back to their previous peak of 5.25%, driven largely by "second round effects" where high wage pressures spill into higher prices for consumers.
Economists on City AM's Shadow MPC called on the Bank to hold interest rates steady, warning that overly aggressive tightening could risk strangling economic growth. Two out of nine economists argued that interest rates should be raised, citing price risks ahead. Economists also cautioned that the Bank faces a significant challenge in maintaining public credibility over its capacity to keep prices stable should inflation climb higher than anticipated.
Rachel Reeves said: "While the war in the Middle East pushes prices up globally, we have got the right economic plan and inflation has held steady."
