- The annual rate of UK inflation fell to 3.2 per cent in March
- Conflict in the Middle East might make rate-setters wary of another inflation shock
The headline rate of UK inflation fell to 3.2 per cent in March, a slightly higher figure than analysts expected. Core inflation, which strips out more volatile food and energy prices, slowed to 4.2 per cent, down from 4.5 per cent last month.
According to the Office for National Statistics (ONS), food prices made the biggest downward contribution to the headline figure, but this was partially offset by an upward contribution from motor fuels. Services inflation, a metric closely watched by Bank of England rate-setters eased slightly from 6.1 to 6 per cent.
Return to the 2 per cent target next month
Though the latest headline number shows only a small drop on February’s 3.4 per cent figure, economists anticipate a larger jump next month. Many forecasters – including the Bank of England – expect a return to the 2 per cent target due to improvements in core inflation and the lower price cap on household energy bills. This puts the UK at odds with the US economy, where progress back to the inflation target has proved frustratingly slow.
The headline rate of US inflation has hovered around 3.5 per cent since June last year (see chart), and the past few months have also seen some blockbuster growth and labour market data.
Following a raft of resilient prints across the Atlantic, markets expect just two quarter-point rate cuts in 2024, with the first coming as late as September. In January, traders expected a first rate cut in March and six cuts this year.
Middle East conflict increases inflation risks
There are fears that the UK could also suffer a difficult ‘last mile’ back to the 2 per cent inflation target – especially given the escalation of conflict in the Middle East. Brent crude oil prices have risen from $76 per barrel to $90 since the start of the year, and there is a risk that higher energy prices could put upward pressure on the inflation rate again.
BoE rate-setters are sensitive to the risk of further external shocks, noting earlier this year that “potential supply shocks such as the Red Sea disruption” could boost inflation.
So far, the impact looks relatively contained. Analysts at Capital Economics calculated that oil prices would have to reach $110pb while UK wholesale gas prices would need to rise from 76p to 150p per therm for inflation to remain ‘stuck’ above 2 per cent.
Analysts still expect the inflation rate to fall over 2024, with the BoE’s Monetary Policy Committee (MPC) voting to cut rates as early as June. Nevertheless, they warned that if energy prices do rebound, “the Bank may cut interest rates later and slower”.
When will the Bank of England cut rates?
Even if tensions in the Middle East don’t change the inflation outlook, they could still encourage hawkish rate-setters to be more cautious. Last week, the MPC’s Megan Greene argued in the Financial Times that inflation would remain higher for longer in the UK, thanks to the “double whammy of a very tight labour market and a trade shock from energy prices”. She added that “rate cuts in the UK should still be a way off”.
In the last meeting, some policymakers voiced concerns wage growth was "too high" and would "moderate only slowly”.
Tuesday’s labour market data may not be enough to reassure them. Earnings figures came in above expectations, with growth in average weekly earnings (including bonuses) holding steady at 5.6 per cent. Rate-setters are also keen to see how April’s increase in the National Living Wage feeds through to inflation figures, with some estimates suggesting that it could increase average pay growth by 0.3 percentage points this year.
The latest release also showed a slight uptick in the unemployment rate – though the ONS warned that jobs data should be treated with caution because of problems with survey methods. The unemployment rate averaged 4.2 per cent in the three months to February, up 0.3 percentage points from the previous three-month period. Following the release, Yael Selfin, chief economist at KPMG, said that the rise in the unemployment rate "paints a picture of a less tight labour market”.
After the latest labour market figures, Axa economist Gabriella Dickens said that a June rate cut “looks most likely” given that the impact of the National Living Wage hike will be visible in the data by then. Selfin thinks that the BoE remains “on track for a summer rate cut”, but added that the exact timing of the first rate cut will be a "hot debate" for the MPC. Market pricing indicated between one and two quarter-point rate cuts before the end of 2024.
