UK inflation: Will tomorrow’s ‘make or break’ figures trigger a cut in interest rates and what happens next?

The headline inflation rate is likely to have fallen sharply in April but there are concerns over the level of services-related inflation.

Wednesday’s inflation numbers have been described as a “make or break” for the Bank of England as it hums and haws over cutting interest rates.

Millions of mortgage holders, borrowers and businesses were left facing an extended period of financial pain earlier this month when central bank policymakers voted to hold the bank base rate at 5.25 per cent, where it has been for some six months now, following a series of hikes to get inflation under control. That battle looks to have been largely won and the chances of that initial rate cut coming at the Bank’s next rate-setting meeting on June 20 have increased markedly. Indeed, the markets are now pricing a near-60 per cent chance of action next month.

Bank of England governor Andrew Bailey has been increasingly dovish with his comments, more than hinting at a rate cut this summer, which if inflation remains on track, could trigger at least one further cut before the end of the year. So a base rate of 4.75 per cent following two quarter-point cuts looks entirely possible by Christmas.

The official rate of inflation may have been on a downward trajectory in recent months but bills continue to stack up for most consumers and businesses.

Ahead of the crunch inflation data, which is due to be published by the Office for National Statistics at 7am, analysts have been making some predictions. So what is likely to happen?

ING Developed Markets economist, James Smith, said: “It’s no exaggeration to say that this week’s UK inflation data will make or break a June rate cut from the Bank of England. Certainly at a headline level, the story should be a good one. Overall inflation, previously 3.2 per cent, is likely to fall to within a whisker of the Bank’s 2 per cent target. Some of this can be traced back to the 12 per cent fall in household electricity/gas bills that we saw at the start of April. And we’re likely to see something similar again in July.

“But in the very short term, there’s still some uncertainty over services inflation. That’s ultimately what the BoE is most interested in, and it seems to have assumed even greater prominence in the monetary policy decision-making process given recent volatility in the wage figures. Again the story here is improving, but crucially we think the risk to this week’s services inflation figure is to the upside.

“April is a time where several price categories see annual price resets, often linked explicitly to prior rates of headline inflation. Just think of phone or internet bills, for example. Social rents are another key area to watch.

“The bottom line is that if the data comes in line with expectations, a June rate cut would quickly become the base case. But given the [monetary policy] committee is visibly divided, a bigger upside surprise to services inflation this week would move the dial back towards August for the first rate cut. That’s been our long-held base case, and we’ll review that after this week’s data.”

At May’s rate-setting meeting a couple of week’s ago, in a strong signal that the tide may be turning, two members of the nine-person monetary policy committee (MPC) voted for interest rates to be cut by a quarter point, up from just one member in March. Bailey said there had been “encouraging news” on inflation which the Bank expects to come close to its 2 per cent target between April and June. At the last reading, it stood at 3.2 per cent having hit an October 2022 peak of 11.1 per cent.

Luke Bartholomew, senior economist at Scottish funds heavyweight Abrdn, noted: “Wednesday’s inflation report is likely to show that UK inflation fell sharply in April, with the headline rate likely to be at or around the inflation target of 2 per cent. While returning to this inflation target is psychologically significant, and symbolic of how much progress has occurred since inflation peaked above 11 per cent, it is unlikely to be the number watched most closely by the Bank of England and investors.

“Instead, it is services inflation that will likely decide how the Bank of England judges the report, and in turn how markets assess the likely path of interest rate policy. This is because services inflation better reflects the underlying trends in inflationary pressures, which will ultimately determine how inflation behaves in the medium run.

“With wage growth surprising to the upside last week, policymakers at the Bank will want to see signs that higher wage growth is not being passed on to higher services inflation. If services inflation comes in line with expectations, this will keep a June rate cut in play. But a large upside surprise will likely see the market scale back its bets on a June cut, and start to look to August for the beginning of the easing cycle.”

The next two meetings of the MPC take place on June 20 and August 1.

Official inflation figures follow news that grocery price inflation has slowed to its lowest level since October 2021. Supermarket prices are on average 2.4 per cent higher than a year ago, slowing for the 15th month in a row from April’s 3.2 per cent, according to industry analysts Kantar. Grocery inflation is now just 0.8 percentage points above the ten-year average of 1.6 per cent between 2012 and 2021, just before prices began to climb.

Cheaper supermarket own-label lines are proving resilient, and are still growing faster than major brands, making up more than half (52 per cent) of total spending, Kantar noted.

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