Inflation set to return to 2% target for first time in almost three years

Inflation is expected to have fallen back to the 2% target for the first time in nearly three years in official figures on Wednesday that come just a day before the next rates decision and at a crucial time for the Conservatives ahead of the polls.

Most analysts are forecasting official figures will show the Consumer Prices Index (CPI) dropping to 2% in May, down from 2.3% in April.

It would mark the first time inflation has been at the Bank of England’s target since July 2021, before the cost-of-living crisis saw inflation shoot up – at one stage hitting levels not seen for 40 years.

A return to target will give a pre-election fillip to the Conservatives, with Prime Minister Rishi Sunak having been quick to declare victory on inflation already last month – even though inflation was always expected to fall sharply as rising energy and food costs subside.

But experts said it is unlikely to boost chances of an early summer interest rate cut.

Most economists believe the Bank of England will hold rates at 5.25% on Thursday, with the election denting hopes of a reduction before the nation head to the polls on July 4.

Investec economist Sandra Horsfield said: “Welcome though a return to target inflation would be, the MPC (Monetary Policy Committee) is unlikely to be fully satisfied should the numbers meet our expectations.

“In the (Bank’s) May Monetary Policy Report, the baseline forecast was for a 1.9% inflation rate.

“Nor it is clear that inflation will stay at 2% from now on – In fact, we expect a small rise again over the second half of the year.”

She added that while a June move looks unlikely “amid a pre-election purdah period”, there are still hopes for rates to be reduced in August.

While a return to target is symbolic, the Bank is keeping a watchful eye on inflation in the services sector, which is proving more stubborn and has been partly responsible for staying its hand in bringing rates down from their 16-year high.

Policymakers have also been focusing on wage growth, which has likewise remained resilient, leading financial markets to pencil in just one rate cut this year.

Economists see this as being overly pessimistic, but Robert Wood at Pantheon Macroeconomics said it is clear the MPC “still has work to do”.

He expects services inflation to remain above the Bank’s own forecasts once again in May, but thinks it will overlook this for the August decision, when it will have the next set of quarterly forecasts.

“We think the MPC will still cut Bank Rate for the first time in August, even if services inflation overshoots its forecast,” he said.

“As long as services inflation keeps slowing, the next CPI print should give the MPC more confidence to trust surveys which suggest inflation will continue to ease.”