Services Inflation Poses Risk to Summer Interest Rate Cuts

Main points

• Today’s ONS figures indicate that annual CPI inflation was 3.2 per cent in March, falling from 3.4 per cent in February, and representing the lowest annual CPI inflation figure since September 2021. This figure reflects upward contributions, such as those from motor fuels, being offset by downward contributions, such as in food and alcoholic beverages
• This fall in the annual CPI inflation rate was expected, given base effects from the large energy and food price increases observed in March 2023. Inflation is set continue falling in the first half of 2024, partially due to further base effects as well as the April Ofgem energy price cap cut. Though this is positive, it will be important to keep an eye on month-on-month inflation figures (essentially ‘new’ inflation) to determine to what extent we will see inflation rebound in the second half of 2024. In fact, the pace at which inflation softened in March was slower than we expected, due to higher than projected month-on-month inflation
• While indicators of underlying inflationary pressures all fell on the month, they remain high, which may require the MPC to exercise caution in monetary loosening. NIESR’s measure of underlying inflation, which excludes 5 per cent of the highest and lowest price changes to eliminate volatility and separate the signal from the ‘noise’, fell to 3.1 per cent in March from 3.9 per cent in February; core CPI fell to 4.2 per cent from 4.5 per cent; and services inflation fell to 6.0 per cent from 6.1 per cent. These measures indicate that underlying inflationary pressures remain elevated – and well above the 2 per cent target
• As a result, we think the Bank of England may need to exercise some caution in its expected upcoming monetary loosening. Indeed, we may not see a rate cut in May due to insufficient evidence of cooling underlying inflationary pressures. Whether a cut will come in June or August will become clearer next month

“Annual CPI inflation was 3.2 per cent in March, falling from 3.4 per cent in February, driven by downward contributions from food. Today’s core inflation figure of 4.2 per cent indicates that underlying inflationary pressures continue to ease, but remain above their historical average. With inflation set to fall further in April, possibly below the Bank of England’s 2 per cent target, the MPC will be closely watching movements in core CPI ahead of its upcoming meetings.”

Paula Bejarano Carbo, Economist

For a breakdown of what inflation is and how it is calculated, read our blog post here.