Inflation set to hit Bank of England’s 2% target, but MPC not expected to cut interest rates

Inflation is set to hit the Bank of England’s 2% target when official figures for May are released tomorrow, but it is not likely to be enough to make the Bank of  England cut interest rates this week, City economists say.

According to a survey of economists for data provider Refinitiv, inflation is set to fall to exactly 2% when May figures are published tomorrow.

That would bring the rate of price rises back to the Bank of England’s target figure for the first time since July 2021. 

The lower energy price cap in April helped bring inflation for that month close to the Bank’s target, but it remained slightly above at 2.3%. In May, it’s hoped that the continued easing of food prices will help bring inflation down.

Edward Allenby of Oxford Economics said: “The bulk of the downward pressure in May is likely to have come from the food and core categories, where base effects and the indirect effects of lower energy prices continue to weigh on the annual headline inflation rate.”

While the fall in inflation to the 2% target will be seen as a major milestone, it is not likely to prompt an immediate interest rate cut from the Bank of England. The Bank’s Monetary Policy Committee remains concerned that underlying price pressures remain high, and that the rate of inflation could climb back up later in the year. The Bank aims to bring inflation to 2% over the “medium term”, rather than targeting it immediately.

Policymakers on Threadneedle Street have pointed to the higher rates of core inflation and service-sector inflation as signs that price rises could re-accelerate. Both rates are expected to decline in May, but will still be higher than the Bank deems consistent with sustainable 2% inflation.

Core inflation is set to decline from 3.9% to 3.5%, the economists say. Service-sector inflation, which was 5.9% in April, is expected to dip to 5.6%. Both figures could be impacted by second-round effects from April’s minimum wage rise.

City markets see a cut when the Bank of England meets this week as extremely unlikely, pricing in only a 9% chance of a move in the final meeting before the General Election. August had previously been circled as a likely date for a cut, but the current consensus is that a move is more likely to happen in the Autumn, in September or November. 

If inflation falls faster than expected, and therefore below the 2% target, it may encourage the bank to cut sooner. However, regardless of the figures this week, a June cut appears unlikely. Markets instead will be closely watching the voting figures and comments from the Bank that accompany the decision, in a hunt for signs that a cut could  be on the agenda at the next meeting.

Steve Matthews, investment director for liquidity at Canada Life Asset Management, said: “We expect a 7-2 vote in favour of no cut. Despite recent data supporting a cut – such as the unemployment rate rising to 4.4% and expectations that the CPI will hit 2% on Wednesday – concerns about upcoming wage data and services inflation persist.

“While the European Central Bank made a move last week, the Federal Reserve is taking a more cautious approach. This gives the Bank of England additional opportunity to make a well-timed decision.

“Although there is light at the end of the tunnel, we are still firmly in the tunnel. We maintain our view that a first cut of 25bps in August is still the most likely scenario.”