UK reaction: Changing our Bank of England call to August, from June

The call between June and August was always finely balanced and April’s CPI data have tipped the scales towards an August cut in our eyes. While the headline rate ticked down to 2.3% ‑ its slowest pace since July 2021 – from 3.2% in March, that was above both the MPC’s and analysts’ expectations, 2.1%. Core inflation also ticked down, but at 3.9%, it was well above the expected 3.6%. Worryingly, the upside surprises were mainly focused in the services sector, leaving services CPI inflation down just 0.1 percentage points at 5.9%, compared to 6% in March. Note that the MPC are placing more weight on services CPI inflation at the moment to guide them on the persistence of the second-round effects on wages and domestic prices, given the inadequacies of the labour market data. The Committee made it pretty clear in the May meeting that if the upcoming data progressed in line with their expectations, a June cut was firmly on the cards, but this hurdle was not cleared.

As expected, Ofgem’s 12.3% drop in the Energy Price Cap drove April’s decline, knocking off 0.44pp from the headline rate. Food price inflation also continued to slow, falling to 2.9% in April, from 4% in March, shaving off a further 0.14pp, while alcohol and tobacco cut off 0.16pp. Meanwhile, non-industrial energy goods inflation dropped sharply to 0.6% in April, from 1.5% in March, reflecting discounting in both furniture and clothing.

The main upside surprise was in services. While hefty increases in prices were expected across a range of items, such as mobile phone bills and rents, the upside surprises in services inflation were broad-based. The biggest contribution was from restaurants and hotels CPI which added 0.85pp to the headline rate. Within that, accommodation services rose by 0.9% on the month, after jumping by 3.8% in March, leaving prices up 4.8% across the two months, compared to 3% over the same period in 2023. Underlying inflation in this sector is strong and likely will remain so over the coming months as the near-10% hike in the National Living Wage puts upward pressure on wage growth. Recreation and cultural services, meanwhile, increased by 3.6% month-to-month in April, adding 0.62pp to the headline rate. And prices for both airfares and package holidays rose by more than analysts had expected.

Looking ahead, we think CPI inflation will continue to tick down next month, as goods and food CPI inflation both continue their decline. Base effects will also help, as the large increases in services prices last year drop out of the annual comparison. But the broad-based strength in services in April means we think the decline will be slow going; core inflation likely won’t fall enough to return the headline rate to target over the next couple of months. The members of the MPC that were close to switching their vote, therefore, will now probably want to wait a little longer to confirm that the second-round effects on wages and domestic prices are fading as hoped. A cut this summer has been widely signalled, so we doubt they will hold out until September, but we have changed our call to August, from June.

The market reacted to the news. Sterling rose against the dollar to a peak of $1.2759, from $1.2707, before edging back to $1.2735. Markets now aren’t pricing in a full cut until November, from August previously.