UK inflation holds at 2.8% in May, trimming BoE rate hike bets

UK inflation unexpectedly held at a 13-month low of 2.8% in May, undershooting the 3% consensus and prompting traders to scale back bets that the Bank of England will need to raise interest rates later this year.

"The softer-than-expected reading will add to hopes that the cost-of-living scare induced by the Middle East crisis will be shorter-lived," said Susannah Streeter, chief investment strategist at Wealth Club. "It shows that despite higher energy costs filtering into fuel prices and air fares, underlying price pressures are easing."

The Consumer Prices Index was unchanged from April's 2.8% reading, the Office for National Statistics said Wednesday, defying the 3.0% median estimate in a Reuters poll of economists. On a monthly basis, CPI rose 0.2% in May, matching the same increase a year earlier. Core CPI, which strips out volatile energy, food, alcohol and tobacco, edged up to 2.6% from 2.5%, while services inflation — a key metric watched by the BoE's Monetary Policy Committee — accelerated to 3.7% from 3.2%.

The data comes a day before the BoE's rate decision on Thursday, where the MPC is widely expected to hold Bank Rate at 3.75%. Prior to the release, some economists had flagged the risk that sticky inflation could force policymakers to signal a potential hike later this year. Those bets have now receded. Overnight-indexed swap markets trimmed the probability of a rate increase in 2026, though the path remains uncertain as the July energy price cap rise — expected to push typical household bills toward 2,000 pounds — threatens to reignite price pressures in the second half of the year.

Transport costs made the largest upward contribution to the monthly change, driven by higher pump prices and air fares, the ONS said. Food and non-alcoholic beverages partially offset the increase, while domestic heating oil prices showed a modest decline. The mixed picture leaves the BoE in a familiar bind: inflation at nearly 1 percentage point above the 2% target, but driven largely by external energy shocks rather than domestic demand. The last time the MPC faced a similar configuration — above-target inflation driven by supply-side energy costs — it held rates steady for consecutive meetings before eventually cutting in December 2025.

The pound slipped against the dollar following the release, with GBP/USD declining as traders repriced the likelihood of tighter monetary policy. The FTSE 100 edged 0.1% lower to 10,479.77, with consumer staples and energy shares weighing on the index. British American Tobacco fell 1.7%, while BP and Shell each declined 0.7% as oil prices held below $80 a barrel.

For households, the relief may be temporary. The energy price cap will rise on July 1, adding roughly 13% to typical annual bills, while businesses continue to pass on higher input costs. The Institute of Grocery Distribution has said food inflation will peak in the second half of 2026. "There are no guarantees that the deal will hold, and even if peace endures, price rises are already baked in through higher input costs," said Sarah Coles, head of personal finance at AJ Bell.

The BoE's next full forecast round is due in August, when the MPC will have two more months of inflation data and a clearer picture of how the July energy cap increase feeds through to the headline rate. For now, the path of least resistance points to a prolonged pause.

This article is for informational purposes only and does not constitute investment advice.