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While Rishi Sunak’s government trumpeted Wednesday’s steep drop in headline inflation, the detail of the report made for uncomfortable reading within the Bank of England.
The drop in the overall rate for April to close to the BoE’s 2 per cent target had been widely expected, given a 12 per cent cut in the regulated energy price cap. But the attention of Monetary Policy Committee members was firmly on underlying components of the consumer price index — and in particular on services inflation.
This gauge is seen by the BoE as the critical indicator of how strong domestic price pressures are as the global shocks that drove up import prices fade. Senior officials have signalled that if services inflation retreats in line with forecasts they should be in a position to cut rates this summer.
But the latest UK inflation figures present a serious challenge to that goal. Services CPI growth slipped only marginally to 5.9 per cent from 6 per cent, leaving it well above the 5.5 per cent level forecast by the BoE only two weeks ago. Gains were broad-based, with restaurants and hotels making the biggest upward contribution to the headline inflation rate of 2.3 per cent.
“This is only one month’s data, but it is enough of a surprise to suggest that the inflation process is not tracking as the BoE had expected,” said Allan Monks of JPMorgan. “The risks have clearly tilted back towards a later cut, and the talking point now will be whether the BoE can ease at all this year.”
Andrew Bailey, BoE governor, has in recent months sounded optimistic about the disinflation process, arguing that the UK, like the Eurozone, is not seeing the kind of demand-driven inflation that is keeping the US Federal Reserve from easing policy.
A key argument advanced by the BoE in this month’s policy meeting, at which it left rates unchanged at 5.25 per cent, was that inflation had been driven more by global factors such as energy and food prices than previously believed — and less by so-called second-round effects playing out in domestic prices.
This underpinned a view among BoE staff that inflation will prove less persistent than earlier forecasts, the governor told an audience in London on the eve of Wednesday’s inflation release.
Officials have drawn comfort from surveys by BoE agents suggesting companies are struggling to pass on their higher costs and wages to consumers, helping pull inflation towards the target — which was last hit in July 2021.
But the stubbornly high prices being charged by the services sector challenge that narrative, economists said.
The uplift in services prices was driven in part by the indexation of items like phone and broadband bills to past inflation rates. But a more worrying possibility is that companies are increasingly willing to pass high wage costs on to their customers.
Official data released last week suggested wage growth was slowing less than policymakers expected, even before a big increase in the national minimum wage took effect in April. Early indications suggest this rise in the wage floor is adding to the pressures.
Pay awards in the three months to April — the busiest period of the year for pay settlements — averaged 4.9 per cent, according to the research company Brightmine. This was higher than the previous rolling quarter and barely changed from the median of 5 per cent seen over the past year as a whole.
Meanwhile Wednesday’s data showed price increases for hotels and restaurants — which are heavily influenced by rising labour costs — were one of the key factors that prevented consumer price inflation falling as much as analysts had expected.
“These latest wage and price numbers could just be a bump in the road,” said Chris Hare, an economist at HSBC. “But on the other hand, they might suggest a risk that UK disinflation is stalling.”
After firm GDP growth of 0.6 per cent in the first quarter, a further pick-up in household spending could make companies more confident about lifting prices charged to consumers. Meanwhile, after being pulled down by the steep fall in energy prices this spring, the headline inflation rate may start drifting higher again this summer as those beneficial effects fade from the year-on-year numbers.
None of this means the BoE’s plan for easing monetary policy this summer has been derailed, and there is still another CPI report, alongside wage and employment numbers, before the rates committee meets to set policy on June 20.
But some economists who had predicted a cut next month were on Wednesday reconsidering their calls, and traders who had been evenly split on the chance of a rate cut by June now place the likelihood of a reduction by August at less than 50 per cent.
“This services CPI number has significantly pushed back BoE rate cut expectations, and with good reason,” said George Moran at Nomura.
Additional reporting by Valentina Romei
