Key facts
- UK inflation remained at 2.8% in May, below the expected 3%.
- Food prices decreased by 0.1% month-on-month, while motor fuel costs rose 25% year-on-year.
- The Bank of England is expected to hold interest rates at 3.75% at its upcoming meeting.
- Financial markets anticipate only one quarter-point rate hike from the BoE this year.
- The full impact of higher fertilizer prices is expected to become clearer over the coming months.
UK inflation held steady at 2.8% in May, defying economists' expectations of a rise and suggesting a milder economic impact from the Iran conflict. The Bank of England is expected to keep interest rates unchanged at 3.75% at its upcoming meeting, as Governor Andrew Bailey indicated the bank has time to assess the situation. Analysts are closely monitoring for any dissent within the Monetary Policy Committee, with some expecting a quarter-point rate hike to bolster public confidence.
Data showed inflation unexpectedly stayed at a 13-month low, with a dip in food prices offsetting rising airfares and petrol prices. Britain's economy shrank 0.1% in April, and labor market data is forecast to show continued weakness. Financial markets are pricing in only one quarter-point rate hike from the BoE this year.
While the full impact of higher fertilizer prices, linked to transit through the Strait of Hormuz, is expected to unfold over months, a tentative truce in the Iran war has eased the BoE's worst-case inflation scenarios. However, the central bank has been wrongfooted by inflation persistence before and is expected to stress its readiness to act swiftly if second-round effects emerge.