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UK inflation drops to Bank of England's 2% target

A customer looks at some goods at the Asda supermarket, in Aylesbury, England, on August 15, 2023. UK annual inflation stands at 7.9 percent, the highest among G7 nations, while the Bank of England is tasked by the UK government with keeping annual inflation at around two percent. (Photo by JUSTIN TALLIS / AFP) (Photo by JUSTIN TALLIS/AFP via Getty Images)
The easing in the inflation rate was driven by a slowdown in price rises for food. (JUSTIN TALLIS via Getty Images)

Inflation has fallen back to the Bank of England’s 2% target for the first time in nearly three years, increasing the prospect of an interest rate cut this summer.

The Office for National Statistics figures show the Consumer Prices Index (CPI) dropped to 2% in May, down from 2.3% in April. On a month-on-month basis, inflation held constant compared to a 0.3% rise last month.

The figure indicates that prices are still rising, but at the slowest pace since July 2021. It comes following a sustained period of high inflation in the UK, which peaked at 11.1% in October 2022 – the highest level since 1981.

Core inflation which excludes food, energy, alcohol and tobacco, as they tend to be volatile, is forecast to have fallen to 3.5% from 3.9%, also as expected.

The Bank of England will look at these numbers on Thursday to decide what to do about interest rates.

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The easing in the inflation rate was driven by a slowdown in price rises for food and soft drinks, recreation and culture, and furniture and household goods.

Prices of food and soft drinks rose by 1.7% in the year to May, down from 2.9% in April, and the lowest rate since October 2021.

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It has eased for 14 months from a peak of 19.2% in March last year, the highest annual rate seen for more than 45 years.

The main downward effects on the inflation rate came from bread and cereals, vegetables, and sugar, jam, syrups, chocolate and confectionery. In each case, prices fell between April and May this year, compared with a monthly rise a year ago.

Services inflation, a key metric that is closely watched by the Bank of England, however, slightly missed analysts' expectations, coming in at 5.7% on the year versus market expectations of 5.5%.

Thomas Pugh, economist at RSM UK, said about services inflation: "This will raise concerns on the MPC that underlying price pressures in the economy aren’t slowing as quickly as expected and makes an August interest rate cut less likely.

"However, we aren’t ruling out an August rate cut. It seems likely that services inflation in May was still being bolstered by the impact of the 9.7% rise in national minimum wage in April, which was a one-off, as inflation in the restaurant and hotels category only slowed by 0.2 percentage points.

"We expect inflation to fall below 2% in June, setting the stage for the MPC to cut interest rates in August.

"Inflation is likely to average a little above 2% for the rest of the year giving the Bank plenty of room to deliver rate cuts.Our base case is still for interest rates to finish the year at 4.5%, but the risks have clearly shifted to fewer cuts this year."

The Confederation of British Industry (CBI) said the stage was now set for the Bank of England to cautiously cut interest rates.

CBI principal economist Martin Sartorius said: "Another fall in inflation in May will come as welcome news to households as we move towards a more benign inflationary environment. However, many will still be feeling the pinch due to the level of prices being far higher than in previous years, particularly for food and energy bills.

"Today’s data sets the stage for the Monetary Policy Committee to cut interest rates in August, in line with our latest forecast’s expectations."

The Bank's Monetary Policy Committee will meet on Thursday, where, due to the proximity of the upcoming election, it is all but certain to keep rates unchanged at 5.25% in order to not influence the political outcome.

Slowing inflation is likely to be well-received by homeowners and buyers pinning their hopes on a summer interest rate cut.

"Mortgage rates have flipped-flopped over the course of the year as financial expectations shifted causing a headache for nervous first-time buyers looking to get a foot on the ladder and existing homeowners hoping for better deals as they come to refinance," Alice Haine, personal finance analyst at Bestinvest, said.

Read more: UK interest rates set to remain on hold ahead of general election

"While easing inflation combined with solid wage growth means affordability levels are improving for buyers as their money can stretch that little bit further, a rate reduction could boost their prospects even further. House prices have flatlined in recent weeks as uncertainty around the timing of a rate reduction and the impact a new government could have on the market causes some buyers and owners to put moving plans on pause," she added.

Watch: What is inflation and why is it important?

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