Inflation eases to 2.3%, but hopes of imminent rate cuts dashed

“Today marks a major moment for the economy, with inflation back to normal,” crowed Prime Minister Rishi Sunak, in response to news that UK inflation eased to 2.3% in April.

Although the consumer prices index (CPI), the UK’s main measure of inflation, came in slightly hotter than the 2.1% economists and the Bank of England predicted, it now stands at its lowest level since mid-2021.

• Invest with ii: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Sunak added that “this is proof that the plan is working and that the difficult decisions we have taken are paying off.

“Brighter days are ahead, but only if we stick to the plan to improve economic security and opportunity for everyone.”

Given the prime minister’s bullish tone, one may assume we can now call time on the harshest cost-of-living crisis since the early 1980s, and the Bank is odds-on to cut interest rates when policymakers meet again in four weeks’ time.

However, that isn’t quite the case. While today’s news will indeed inject some welcome optimism into the future of the UK economy, households are not out of the woods yet, and cautious policymakers still have plenty to consider before loosening up monetary policy.

Energy, food and tobacco inflation fall sharply

The main reason behind April’s sharp decline was tumbling energy and gas prices due to the reduction in the Ofgem energy price cap.

Elsewhere, services inflation fell marginally to 5.9% in April versus 6% the month before, while core inflation (which strips out energy and food costs) softened from 4.2% to 3.9%. Like the headline rate, these also came in slightly more toppy than expected.

The Office for National Statistics' (ONS) chief economist Grant Fitzner said: “Tobacco prices also helped pull down the rate, with no changes announced in the Budget. Meanwhile, food price inflation saw further falls over the year. These falls were partially offset by a small uptick in petrol prices.”

• Sign up to our free newsletter for share, fund and trust ideas, and the latest news and analysis
• Stock markets at records and cash at 5%: what will happen next?

Easing food cost increases has played a key role in inflation’s descent towards normality. Grocery price inflation plunged to 2.4% in May versus 3.2% the month before - its lowest level in more than 2.5 years.

This will bring welcome relief for families, as spiralling prices at the tills has been a painful thread weaved throughout the cost-of-living crisis.

According to data from the ONS, the total price of food and non-alcoholic beverages rose around 25% between January 2022 and January 2024.

To underscore the toll this has taken on household purse strings, in the 10 years prior, prices rose by just 9%.

Imminent rate cut hopes appear dashed

Now that inflation is back close to where it needs to be, the talk of interest rate cuts will inevitably get louder. The speed of price rises is a key metric policymakers consider when deciding whether to reduce, hold or increase bank rates.

However, with CPI coming in slightly higher than anticipated, it seems the prospect of imminent cuts has dwindled rather than increased, with less pressure on the Monetary Policy Committee to act in June.

Bank governor Andrew Bailey has repeatedly stressed that he wants to see firm evidence that inflation will fall to around 2% and stay there or thereabouts.

• How much help do you need when investing?
• Optimism towards UK improves, but pros are not piling in
• FTSE 100 record highs: what does it mean for investors?

Before today’s news, markets placed the odds of a June cut at 50% but have since scaled the probability back to just 15%. Furthermore, the chances of a September cut have now dropped to 80%. It’s possible that the start of the rate-cutting cycle could be pushed back until November.

May’s inflation reading, which will be revealed on 19 June, the day before the next interest rate decision, may have some bearing on what the Bank chooses to do. But this data should only prove marginal. Anyone hoping that rates will be cut in the next month will almost certainly be left disappointed.

The International Monetary Fund (IMF), meanwhile, has recommended that rates should be cut seven times between now and the end of 2025, which would drop the Bank Rate to 3.5%. The IMF suggested two or three reductions this year, with four or five arriving in 2025.

The IMF also upgraded its growth forecast for the UK for 2023 from 0.5% to 0.7%, and predicted growth of 1.5% next year.

Inflation’s path still prompts optimism

Despite denting the hopes of sooner-rather-than-later rate cuts, inflation’s path back towards the Bank's 2% target has happened a lot faster than expected.

Between April and May 2023, CPI remained stubbornly high at 8.7%. Sunak’s pledge at the start of 2023 to halve inflation from its then-level of 10.7% by the end the year looked rather ambitious.

Fast forward 12 months, and not only did Sunak reach his target with two months to spare, but inflation has now almost halved again.

And this is the latest positive economic development on these shores. The news that the UK economy clawed itself out of recession in a remarkably short space of time offers more green shoots for UK’s future.

Too early to call time on cost-of-living crisis

While the rising cost of living has affected all of us in some shape or form, the impact has not been felt equally.

As interactive investor’s senior personal finance analyst Myron Jobson neatly puts it: “We all have a personal inflation number that is unique to each individual. That’s because we don’t all buy the same goods and services. As such, your inflation rate might end up being lower, or higher, than the headline figure.”

What we can’t ignore is that some effects of the past 2.5 years are still yet to seep through.

Softening energy and food prices may bring relief to households, but those with borrowings may feel the pinch for some time yet.

Thousands of mortgage holders will see previously cheap fixed-rate deals expire throughout the rest of the year. And even when interest rates are finally cut, borrowers in this group will roll on to less favourable terms and see their monthly pay packets squeezed by higher repayments.

Even if the Bank adopts the IMF’s suggestions and trims the Bank Rate to 4.5% by the end of the year, interest rates would still be far higher than at any point between the 2008-09 global financial crisis and the start of the cost-of-living crisis.

Let’s, however, round things off on a cheerier note. According to Moneyfacts data, nine in 10 savings deals now beat inflation – good news for anyone looking to ensure that their short-term money retains its value in real terms.

• Three tax breaks you can carry forward and three you can’t
• Making the most of your tax breaks in 2024
• Fund Spotlight: earn 5% on your cash with this £7 billion fund

You will still need to watch out for tax though. If the interest you receive exceeds the £1,000 personal savings allowance (which falls to £500 if you pay 40% and if your income tops £125,140 you pay tax on all interest) and the money isn’t held in a tax wrapper, such as an individual savings account (ISA), HMRC may take a slice of what you earn.

And it isn’t just your Bank savings that are faring well in the fight to outstrip price rises. The highest-yielding money market funds are paying north of 5%, as this excellent article by interactive investor’s Sam Benstead reveals, a further option to put your short-term holdings to best use.

For any money that you can take a longer-term view on, recent stock market performance offers plenty of encouragement. The FTSE 100 has climbed 8.5% since the year kicked off, while across the Atlantic, the S&P 500 has continued its strong run of form. Despite a brief correction in April, the US market has rebounded, ticking up 12.5% since 1 January at the time of writing.