Inflation latest: Major moment as inflation falls to 2% target after three-year battle - here's what it means for interest rates (2024)

There's plenty to cheer following May's inflation figures - but there's one number that is concerning economists.

Experts at Capital Economics say the fall from 2.3% in April to 2% in May "probably" won't be enough to persuade the Bank of England to cut interest rates from 5.25% tomorrow.

We expected this, with many predicting that figure to be cut by the Bank in August, but the economists are now worried about that date too.

"With services inflation nudging down only slightly, this leaves our forecast that the Bank will cut rates for the first time in August looking a little shakier," Capital said.

Both the Bank itself and Capital Economics predicted that services inflation would drop from 5.9% to 5.3% - however, it only dropped to 5.7%.

"As a result, today's release won't alleviate the Bank's concerns about persistent price pressures entirely," Capital concluded.

Pantheon Macroeconomics, another industry-leading research firm, agrees.

"The good news is headline inflation has fallen back to the 2% target for the first time since July 2021," it said in its reaction report.

"The bad news is services inflation has proved remarkably persistent, slowing only to 5.7% in May from 6.1% in February, a period when large base effects should have weighed heavily on the year-over-year inflation rate."

With that in mind, Pantheon described the notion that the Bank would cut interest rates in August as "a longshot".

"Services inflation overshooting the MPC’s forecast by 40bp makes an August MPC rate cut look like a longshot. We will very likely shift our call for the first MPC cut to September, followed by another in November."

But Pantheon emphasised the headline today is good news.

"Among these repeated upside services inflation surprises it's easy to to miss the big picture that headline inflation has returned to the target, and even if CPI inflation rises it will remain below 3%," Pantheon said.

"This is a far cry from the conditions in place when the MPC raised Bank Rate to 5.25%."

Rishi Sunak says inflation falling to target is "great news" - but warned it could rise again if Labour wins on 4 July.

The prime minister said: "Great news this morning that inflation is back to normal at 2%.

"That's lower than Germany, France and America.

"When I became prime minister, inflation was at 11%.

"But we took bold action. We stuck to a clear plan and that's why the economy has now turned a corner.

"So, let's not put all that progress at risk with Labour. All they would do is spend a load of money, push up inflation and cost every working family £2,000 in higher taxes."

Labour has rejected the Tory claim that it is planning £2,000 of tax rises - and analysts say using the same methodology shows taxes would also rise under the Conservatives.

This table shows the annual rate of inflation for various services and goods.

You'll see prices are still rising in almost every sector (though not housing costs ie energy and furniture) - but less, in most cases, in May than April.

As you can see, food and non-alcoholic beverages experienced a heavy drop in the rate of price rises - they were rising 2.9% and now they're rising 1.7%.

The only significant increase in the rate of price rises was in the transport sector - they're rising at a rate 0.4% higher in May.

Clothing and footwear also dropped (by 0.7%) and the communication sector saw a very slight increase (0.1%).

We'll be bringing you the drivers behind today's drop to 2% very shortly.

The UK economy is hailing the return of inflation to the 2% target. For the Conservatives this will be proof their economic plan is working. But Labour is warning that, after 14 years of "economic chaos", today's news isn't a reason to choose the Tories when the country goes to the ballot box on 4 July.

Shadow chancellor Rachel Reeves says the Conservatives' "desperate wish list of unfunded spending promises" will mean more expensive mortgages.

Ms Reeves said: "After 14 years of economic chaos under the Conservatives, working people are worse off. Prices have risen in the shops, mortgage bills are higher and taxes are at a 70-year high.

"Labour has a plan to make people better off bringing stability back to our economy, unlocking investment and delivering reform.

"All the Conservatives are offering is a desperate wish list of unfunded spending promises that will mean £4,800 more on people's mortgages."

Liberal Democrats' treasury spokeswoman Sarah Olney agrees with Ms Reeves, calling it "sheer desperation" from the Conservatives to claim their plan for the economy is working.

"The hard truth is that millions of people won't be feeling any better off today, thanks to years of Conservative economic mismanagement," she said.

"Rishi Sunak's boasts will ring hollow to countless families seeing their mortgages skyrocket and agonising rises in shopping prices compared to just a few years ago."

The pound rose slightly versus theeuro and dollar on the back of the 7am announcement.

The euro dropped 0.04% to 84.46p againstthe pound from 84.48p right before the data.

Sterling wasup 0.05% against the dollar at $1.2713, having tradedat $1.2704 earlier.

This is all positive for holidaymakers and importers - as their pound will go further.

What does this mean for the chances of a summer interest rate cut?

"It's very, very positive news indeed for anyone hoping for an interest rate cut in the very near future," says business presenter Ian King.

"We won't get one tomorrow, of course, because we're in the midst of a general election campaign."

Instead, a cut from 5.25% to 5% is widely expected in August.

King adds that the news - including core inflation falling in line with forecasts - is "a bit of a fillip" for Prime Minister Rishi Sunak and Chancellor Jeremy Hunt.

Business correspondent Paul Kelso agrees that it is "highly unlikely that the Bank of England will move rates tomorrow".

Markets are pricing in an about 50% chance of a first rate cut to 5% by August - and a 0.5% drop in total this year.

This morning's figures will be welcome reading for many of us - but how do we compare with other major economies?

The UK is now in line with the US, one of the world economies which has best been able to manage global inflation, and is performing better than much of Europe.

France and Germany sit at 2.6% and 2.8% respectively, with the wider Eurozone between them at 2.7%.

Core inflation strips out volatile elements such as food and energy and is therefore a better measure of inflation.

It had been 3.9% in April - and the drop to 3.5% was in line with forecasts.

This is another positive sign for those hoping for a summer interest rate cut.

The rate of inflation dropped to 2% in May - down from 2.3% in April and ending a three-year battle to return price rises to target levels.

It hasn't been this low since July 2021 - and is a big turnaround from highs of 11.1% in October 2022 amid an energy crisis caused by the Ukraine war.

A drop to 2% had been forecast in a poll of economists by Bloomberg.

The target for the headline CPI figure is 2% - set by the Bank of England and central banks across the world.

Economists think the Bank of England will still want more evidence inflation is sustainably under control before cutting interest rates - with a hold at 5.25% widely expected tomorrow before a potential cut in August.

Rates are kept high in order to tame inflation by squeezing the economy.

As well as the headline CPI figure, the Bank will be looking at core inflation - which strips out volatile elements such as energy and food - and wage growth.

Business reporter James Sillars writes: "Bank policymakers have repeatedly voiced worries over indicators showing a pick-up in the pace of price increases during the second half of the year.

"They are concerned too that wage growth, running stubbornly at 6% annually at the moment, risks stoking demand in the economy and therefore inflation further.

"Without these factors falling out of consideration, the majority on the rate-setting committee will likely continue to say it's too early to release the chokehold on inflation.

"There is also a school of thought that the Bank would be reluctant to act during an election campaign."

Basically, inflation is the rate at which prices are rising.

It directly affects our overall cost of living and, if wages are not increasing at the same pace, the value of your money decreases.

It is impacted by lots of different factors including global conflicts - with the Ukraine war having a huge impact on food and gas prices in recent years. Some argue Brexit also had a negative impact.

In the UK, inflation is measured monthly - comparing how much prices are going up with the same time a year previous.

The headline inflation figure, which you'll see a lot in the news, measures price rises across a range of products that we need in our daily lives.

The most commonly used inflation index is the Consumer Price Index (this is the update at 7am today) - and the target for many Western governments is 2%.

One thing to note is that falling inflation doesn't mean prices are coming down - just that they're rising less quickly. You'd need a minus figure, or negative inflation, to see prices fall overall.

Why does inflation impact interest rates?

The Bank of England raises interest rates to try to slow spending and encourage saving - when this happens prices/inflation tend to come down.

When inflation falls, interest rates tend to.

Potential winners and losers from high inflation

Overall, a high and volatile rate of inflation is widely considered to be damaging for the economy – but there are some people who could benefit from it.

Workers with wage bargaining power (perhaps those who belong to strong trade unions) can come off better as they can protect their incomes by bidding for higher wages.

Producers could end up benefitting if their prices rise quicker than their costs.

People with stocks or property could also see the value of their assets rise if there is a sustained period of price inflation.

However, retired people on fixed incomes are likely to be worse off as inflation cuts the real value of their pensions and other savings.

The poorest members of the population will also feel the pinch more as costs of borrowing, food and domestic utilities are high.