UK inflation remained unexpectedly stable at 2.8% in May, providing a surprising signal that the economic impact of the Middle East conflict, particularly the disruption to oil supplies via the Strait of Hormuz, may be less severe for UK households and businesses than initially anticipated. This figure, reported by the Office for National Statistics (ONS), defied economists' predictions of a rise to 3% and follows a larger-than-forecast fall in April's inflation data.
The stability comes despite a significant surge in motor fuel costs, which were up an eye-watering 25% in May compared to a year ago. However, this sharp increase in petrol prices appears not to have translated into broader inflationary pressures across the UK economy. Notably, food prices, a key concern for many households, actually saw a slight month-on-month decrease of 0.1%, offering some relief to household budgets.
Initial warnings at the start of March, when Iran disrupted oil supplies, suggested a potential for rampant inflation and prompted investors to anticipate multiple interest rate hikes from the Bank of England. At one point, markets were pricing in as many as three quarter-point rate rises by the end of the year. However, the latest benign inflation data, coupled with earlier better-than-expected economic readings, has led economists to downgrade their inflation forecasts for the coming months and cast doubt on the necessity of further aggressive rate increases.
Analysts, including Andrew Wishart from Berenberg bank, suggest that firms currently lack the 'pricing power' to pass on higher energy costs to consumers. This contrasts sharply with the situation in 2022, when Russia's invasion of Ukraine, alongside strong consumer demand, propelled inflation to a peak of 11.1%. The Bank of England's Governor, Andrew Bailey, has also remarked on this observed lack of pricing power, indicating that businesses believe cash-strapped shoppers would be unwilling to absorb higher prices.
The Bank of England's Monetary Policy Committee is widely expected to maintain interest rates at 3.75% at their upcoming meeting. While most analysts still foresee at least one interest rate rise this year to keep inflation moving towards the 2% target, market sentiment now suggests this is more likely to occur in November rather than September. Furthermore, the recent announcement of a US-Iran peace deal and the hoped-for reopening of the Strait of Hormuz have already seen oil prices fall below $80 a barrel, removing the Bank's worst-case scenario and potentially shifting their focus from rising prices to concerns about the jobs market downturn.
Source: The Guardian, Office for National Statistics (ONS), Berenberg bank