Inflation Holds Steady, Easing Pressure on Bank of England Rate Hike

Inflation remained unchanged at 2.8 percent in May, according to the Office for National Statistics (ONS), a development that has all but eliminated the prospect of an immediate interest rate hike by the Bank of England. Forecasters had anticipated inflation to rise to 3 percent, partly due to concerns over oil and gas supply disruptions stemming from the conflict between the US and Iran.

The ONS report indicated that while consumer prices remained stable, the war did contribute to increased fuel costs, with petrol prices reaching an average of 157.4 pence per litre in May, the highest since November 2022. Fuel price inflation hit 24.6 percent. Air fares and vehicle taxes also saw increases, though these were counterbalanced by lower food prices.

Markets have responded to the stable inflation data by adjusting their expectations for interest rate changes. Previously, traders had anticipated as many as four rate increases in 2026. However, yesterday, they were pricing in only one increase for the year. The probability of rates remaining unchanged at the Bank of England's current meeting was 96 percent, with an 80 percent chance of no change at the subsequent July meeting. This suggests any potential rate increase is now more likely to occur in the autumn.

Some economists are now suggesting that with the economy showing signs of weakness and the job market facing challenges, the Bank of England's Monetary Policy Committee might consider a rate cut in the future. Despite the overall stable inflation figures, underlying price pressures persist. Services sector inflation climbed to 3.7 percent, and a separate measure of raw material and fuel inflation for manufacturers reached 8.7 percent, its highest point since February 2023. Additionally, a further increase in headline inflation is expected in the summer when the energy regulator Ofgem's next price cap takes effect, potentially raising typical annual household energy bills by 13 percent.

Yael Selfin, chief economist at KPMG, commented that the latest data supports a continued cautious approach from the Bank of England, noting that underlying inflationary pressures have not yet shown clear signs of strengthening. David Hollingworth, associate director at L&C Mortgages, described the inflation reading as a "nice surprise" that should benefit mortgage borrowers. He added that with market expectations aligning with a rate hold, there should be no negative impact on mortgage rates. The easing of swap rates following the announcement of a peace deal between the US and Iran, and the recent inflation figures, are expected to contribute to the continued decline in fixed mortgage rates.