Could inflation dip below the Bank of England’s 2% target this week?

Inflation is expected to fall to its lowest level in nearly three years when new figures are released on Wednesday, potentially dropping below the Bank of England’s 2% target.

The consumer prices index (CPI) measure of inflation was 3.2% for March, according to the Office for National Statistics (ONS).

This Wednesday (22 May), the ONS will announce the inflation figures for April.

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The Bank of England forecast for April CPI is 2.1% while a Reuters poll of City economists also has a consensus of 2.1%.

However, Capital Economics thinks that inflation may have dropped further, and predicts that the data will show a reading of 1.9%.

Ashley Webb, UK economist at the consultancy, comments: “Wednesday’s release of April’s CPI inflation data could be momentous if we’re right in thinking that inflation fell from 3.2% in March to below the 2.0% target for the first time in three years. We have been forecasting this since early 2023.

“Moreover, with CPI inflation at 3.4% in the US and 2.4% in the eurozone in April, this would mean we were right in predicting that the UK would win the race to get inflation below 2.0%.”

We look at the outlook for inflation in more detail, and what it means for interest rates. Could we see the Bank moving to cut rates as early as next month?

Inflation outlook 

While Capital Economics is expecting CPI inflation to drop to 1.9%, it admits there are some risks to its prediction.

For example, it says firms may have raised “their selling prices by more than we expect due to April’s rise in the minimum wage”.

Looking ahead, it is forecasting that inflation will fall further, perhaps to 1% later this year. 

At the start of the year, the consultancy warned about the risks of deflation, saying that a large drop in the energy price cap could lead to a big fall in inflation. The energy analyst Cornwall Insight is expecting the energy price cap to fall by 7% on 1 July. 

The price cap has already fallen this year, down a massive 12.3% last month. 

Daniel Casali, chief investment strategist at the wealth manager Evelyn Partners, thinks that CPI inflation will come down at least to an annual 2% for April “and perhaps lower”.

He explains: “The main driver behind the fall in inflation will be the 12.3% cut to the Ofgem price cap on household dual-fuel energy bills.

“Aside from energy prices, inflation is being led lower by the core goods component. In March, this slowed to an annual rate of just 0.8%, its lowest level since just after the pandemic in 2021. Importantly, core producer price inflation - which can be a good forward indicator - is running at just 0.1% and points to more downside in inflationary pressures.”

Chris Justham, managing director, intermediary solutions, at the investment firm 7IM, agrees that Wednesday’s announcement is “expected to confirm inflation continues to decelerate. The [2% target] has made this release more relevant than most”.

He says that the “worst of the supply-demand imbalances are behind us and business surveys on prices are suggesting a return to normal inflation (albeit at higher starting price levels). So, the evidence is building towards a much more benign inflation picture than we’ve seen over the last few years".

However, Andrew Sentance, a former member of the Bank’s Monetary Policy Committee (MPC), believes that April’s inflation figure will be higher than expected. 

He posted on the social media platform X: “On Wed, UK CPI inflation (April) should drop to 2.7pc, with “core” inflation at 3.8pc and services prices up 6pc. Many April price rises coming through - water, broadband, etc, offsetting energy price cuts. Higher motor fuel prices & wage rises preventing a bigger inflation fall.

“My forecast of 2.7pc UK CPI inflation is much higher than Reuters consensus of 2.1pc among City economists. They appear to be greatly underestimating the momentum of underlying inflation coming from wage rises and the services sector.”

When will interest rates be cut?

Markets are pricing in a base rate cut in the summer, but it is not clear whether they will start in June or August.

Interest rates have been held at their 16-year high of 5.25% for the last six MPC meetings.

Today (20 May), the Bank of England gave its strongest hint yet that interest rates could be lowered this summer.

Bank deputy governor Ben Broadbent said in a speech that a base rate cut over the summer was "possible".

Capital Economics predicts that the first rate cut will happen at the next MPC meeting, on 20 June.

It also thinks interest rates will fall from 5.25% now to 3.00% next year. 

Casali says an interest rate cut at the June meeting is a “distinct possibility”. However, he adds: “Before that meeting there will be one more CPI print [the May inflation data] that could either win round a majority of Monetary Policy Committee members to a rate cut – or dissuade them from it.”

Justham at 7IM points out that it won’t just be financial experts looking closely at Wednesday’s inflation figures.

He tells MoneyWeek: “Some of the keenest observers of this week’s release will be from the political world. It seems broadly acknowledged that the date of a general election is contingent on Rishi Sunak pointing to inflation being under control. So, perhaps another metric to measure this week is how many summer holidays are booked or cancelled from the streets of Whitehall.”