Inflation pressures in the UK are expected to ease a bit, even after a significant rise in April. The annual inflation rate for May is projected to drop to 3.4% from 3.5% in April. At the same time, core annual inflation may decline to 3.5%, a decrease from 3.8%. April saw an unexpected rise in services inflation, which may decrease in May. A mistake in data from the Department for Transport, particularly regarding vehicle excise duty, will be corrected in the May report by the ONS. Additionally, high airfares in April coincided with Easter, which will not occur in 2024 as Easter was in late March.

Price Pressures And BOE Action

Even with the anticipated decline, the BOE is still worried about price pressures. With inflation above 3% and the retail price index over 4%, consumers are feeling the impact of rising costs. The BOE aims to bring inflation down to 2%, requiring further action. The upcoming inflation report is not expected to change views on BOE meetings. Current projections indicate an 88% chance of keeping the bank rate steady, with possible cuts anticipated, including a 25 bps reduction around September and a total of 50 bps cuts by year-end. Though May is likely to show some cooling in both headline and core inflation, the overall journey to the Bank’s target is still a long way off. The expected drop in this month’s data is mainly due to technical corrections and temporary factors from last month that inflated prices. The spike in services inflation in April, largely due to travel costs and a classification error, is expected to unwind, helping to lower the month-on-month rate. The Office for National Statistics has already pointed out that the previous rise was due to mistakes in recording vehicle-related duties, which are now being adjusted. This adds credibility to forecasts of a moderate pullback. Therefore, we are looking at a short-term rebalancing rather than a significant economic change. This distinction matters. Mann and the committee continue to stress that domestic price pressures, especially in services, remain too high for any quick changes. They are closely monitoring wage growth, stubborn housing costs, and ongoing supply issues—all of which affect core inflation readings over time. While the headline number may ease slightly, it needs to be viewed in context; one or two data points will not shift the policy direction.

Expectations And Market Reactions

Expectations for the next few MPC meetings remain stable. Markets seem to have ruled out a summer rate cut, with September appearing more likely for a modest reduction. Nobody is anticipating a swift change in policy, and the implied forward curve stays cautious but steady. For shorter-dated derivatives, there is little reason to take aggressive positions against the current policy. Market volatility has decreased, and unless there is unexpected wage data or global shocks, the front-end is likely to remain within a range. Further out, slight steepening could happen as subdued inflation data brings the bank closer to its medium-term goals. Price movements have already shifted toward a dovish outlook since earlier this year. The potential for repricing has become limited, especially for one-year contracts. We have observed that any upside surprise in inflation figures usually triggers a stronger reaction than equivalent dovish news, showing continued sensitivity to inflation risks. What is crucial now is not just the headline drop, but how it affects rate expectations for the second half of the year. September is still a possibility, especially if core metrics decline along with headline inflation in the upcoming reports. A genuine downward trend could support the idea that some policymakers are waiting before making any changes. In the coming weeks, any positioning should focus on gradual changes rather than major shifts. Data dependence is high. We’re in a phase where small economic changes will significantly influence pricing models. Be mindful of this asymmetry; while there may be limited movement in either direction, the reaction remains sensitive to ongoing trends. Regarding implied rate volatility, it’s becoming less advantageous to position around short-term policy differences, given the BOE’s clear wait-and-see stance. Cross-market trades based on major central bank differences could gain traction, especially if the ECB eases this summer while other central banks maintain their positions. This situation is worth watching. Create your live VT Markets account and start trading now.

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