Inflation came in lower than expected in May, holding steady at a one-year low of 2.4%. Analysts were predicting prices to climb marginally by 0.1% to 2.5%.
Rising oil prices were the single biggest contributor to inflation last month and helped to drive up air and sea fares, according to the Office for National Statistics.
However, declining prices in food and non-alcoholic beverages, electricity, furniture and computer games prevented inflation from ticking upward.
Inflation in the UK has been on the decline since last November when it was 3.1%.
Softer wage growth
While it has now been closer to the Bank of England’s target range of 2% for two consecutive months, yesterday’s unexpected dip in wage growth has made the prospect of a summer rate hike even less likely, according to commentators.
The ONS reported on Tuesday that earnings growth including and excluding bonuses dipped by 0.1% to 2.5% and 2.8% respectively.
Thomas Wells, manager of the Smith & Williamson Global Inflation-Linked Bond fund, said he was more concerned by the unexpected slow in wage growth than the stagnant inflation figures.
“One would not expect that at this stage of the cycle” he noted, particularly when “inflation remains healthy”.
Wells said the data puts further pressure on the Bank of England to leave rates where they are.
“The Bank of England would clearly like to have some meaningful firepower in its pocket for when the next slowdown comes, but it increasingly looks like UK interest rates might not go up this year.”
Rising oil, weak sterling
AJ Bell chief investment officer Kevin Doran agreed that the monetary policy committee will be watching inflation very closely to see whether this is a temporary blip or a total reversal.
The MPC voted 7-2 against an interest rate hike in May.
“The rising oil price and recent weakness in the pound are unlikely to help here,” added Doran.
“The jump in the oil price has started to hit petrol pumps, pushing up costs for UK consumers and businesses alike. In addition, the weak pound will be driving up input costs for many UK companies which will ultimately filter through to UK consumers in the coming months.”
The price of Brent Crude has risen from $49 per barrel to around $76 p/b within the past 12-months.
Sterling, meanwhile, has slumped since mid-April and is now at $1.33 against the dollar.
Brexit
Brexit will also be critical in determining the UK’s inflation trajectory, given its impact on the value of the pound, said Nick Dixon, investment director at Aegon.
“The quality of Brexit, specifically the extent to which a final agreement keeps trade flowing freely and provides confidence for new investment, will impact the level of sterling and hence inflation.”
If wage pressure leads to “cost push” inflation as sterling depreciates, then “there will be pressure for interest rates to rise higher and faster than markets currently expect,” he said.
