Inflation back to Bank of England target – what does it mean for you?

The Consumer Prices Index (CPI) slowed again in May, hitting the Bank of England’s inflation target for the first time in almost three years. When will interest rates go down?

Stack of pound coins on financial graphs and figures.
(Image credit: BrianAJackson via Getty Images)

UK inflation slowed to 2% in the 12 months to May, down from 2.3% in April. This is the lowest level in almost three years, according to data from the Office for National Statistics (ONS). Prices are still rising but at a significantly slower rate than they once were. Inflation peaked at 11.1% in October 2022. 

Economists will not be surprised by the reading. They had expected the headline inflation rate to fall back to 2%, according to a recent poll from Reuters. However, it’s unlikely to be enough to prompt the Bank of England to cut rates at its Monetary Policy Committee (MPC) meeting tomorrow. Most experts believe August is the most likely month for a first cut. 

We share our analysis on this morning's data. What’s next for the economy and when will the Bank of England cut interest rates? Plus, what does the latest inflation reading mean for consumers, savers and mortgage holders? 

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Why has UK inflation slowed?

The largest downward contribution to the CPI rate came from food, the ONS reports. Food prices fell this year but rose a year ago, it adds. Meanwhile, the largest upward contribution came from motor fuels, where prices rose slightly this year after falling a year ago.

Inflation has been gradually slowing from its peak as the pandemic recedes further into the background, supply chains normalise, energy prices fall and higher interest rates take effect.

While the headline rate of inflation is back to 2%, core and services inflation remain elevated. Core inflation came in at 3.5% in the 12 months to May, down from 3.9% in April. Meanwhile, services inflation came in at 5.7%, down from 5.9%. 

Core CPI excludes volatile measures such as energy, food, alcohol and tobacco. It is a better measure of how embedded inflation is in the economy. Meanwhile, the Bank of England keeps a close eye on services inflation, as the UK is a service-oriented economy. 

“Hitting the 2% inflation milestone will be a major moment for the BoE after a long, drawn-out battle to bring rampant inflation down from the double-digit levels seen just over a year ago,” says Alice Haine, personal finance analyst at Bestinvest. 

However, “while the news will be comforting for households, it is unlikely to result in an immediate rate cut tomorrow,” she adds, pointing to the core and services inflation figures.

When will interest rates fall?

The Bank of England will announce its next interest rate decision tomorrow, 20 June. Most economists do not expect the MPC to cut rates at this meeting. 

While governor Andrew Bailey has previously indicated that things are “moving in the right direction”, April’s inflation reading (2.3%) surprised to the upside last month. As well as core and services inflation proving sticky, wage growth is still coming in fairly strong at 6% too. The Bank of England keeps a close eye on wages as they are a key driver of inflation. 

What’s more, with a general election fast approaching on 4 July, the Bank of England could be worried that a June rate cut would end up being politicised. Rishi Sunak has already claimed that a vote for the Conservatives is a vote for interest rate cuts. 

“We are the party who has committed to bringing down inflation, which is the necessary condition for bringing down interest rates,” he told The Times

As global inflationary pressures continue to cool, several central banks have started cutting interest rates in recent weeks. The European Central Bank (ECB) made its first interest rate cut in almost five years earlier this month, joining the likes of Sweden, Switzerland and Canada, who have also started to loosen their monetary policy.

Meanwhile, when it comes to the Bank of England, a little more patience is likely to be required. In a recent poll from Reuters, 63 out of 65 economists voted for August as the most likely month for a first cut to the base rate. The two economists who disagreed with the consensus pointed to September, with none of the respondents voting for June. 

This is a marked change from a few weeks ago. Before April’s inflation data was released, economists had been split between June and August. 

Is the cost-of-living crisis over?

“The return of inflation to the Bank of England’s 2% target is not the end of the cost-of-living crisis but it may mean we are through the worst,” says Tom Stevenson, investment director at Fidelity International. 

Nevertheless, in the leadup to the general election, the latest inflation reading is likely to be “highlighted by the government as evidence that the economy has stabilised, despite growth stagnating in April,” he adds.

The good news for workers is that real wages have been rising as inflation slows. This should mean they are seeing their money stretch further. They will also have benefitted from “two cuts to the headline rate of National Insurance this year”, Haine points out.

Despite this, interest rates remain high and many mortgage holders are in for higher costs once their fixed-rate period comes to an end, if it hasn’t ended already. Recent analysis revealed that hundreds of thousands of fixed-rate mortgages are set to expire before the general election. 

On top of this, the unemployment rate continues to pick up, climbing to 4.4% in the three months to April. This is the highest rate since September 2021. This could suggest higher interest rates are starting to have a negative impact on businesses. Any threat of layoffs would be worrying news for workers.

Haine points out that the general election could throw further uncertainty into the ring. “A new government has the potential to bring in a raft of changes with their own implications for people’s personal finances,” she says. 

Her advice to those with “lingering financial concerns” is that they “stick on the cautious path for now, reining in expenditure where possible, keeping emergency funds topped up and paying down expensive debts”. She also suggests “considering how to save and invest in a tax-efficient way”. 

See our ISA guide for information on how you can shield your cash savings and investments from the taxman. 

Is it time to fix your savings?

A lower rate of inflation is usually good news for savers. It means the purchasing power of their hard-earned cash is no longer being eroded at such a fast rate. If inflation had stuck around at its peak of 11.1%, it would only have taken around six years for the value of your savings to halve.

The bad news is that, once interest rates are cut, savings rates are likely to fall too. Some of the best deals are already being pulled from the market – which means you will need to act fast if you want to take advantage while they last.

For now, a huge number of providers are offering inflation-busting rates. What’s more, the best easy-access savings accounts are paying interest at a rate of 5% or more. If you want to lock these attractive rates in for longer and don’t need to access the money in the short term, you could consider fixing your savings

“The implications of any possible reductions to the base rate may mean some people will be keen to grab a deal quickly and review their existing accounts,” says James Hyde, spokesperson at Moneyfacts.

He adds: “For those willing to lock their cash away for a set period, there are still some one and two-year fixed bonds paying over 5% interest. Some easy-access accounts also pay above this threshold at present, though these rates are subject to change with very short notice.”

What does the latest inflation news mean for mortgage holders?

Mortgage holders are eagerly anticipating an interest rate cut from the Bank of England. Any news that brings them closer to this event will be gladly received. 

Mortgage rates skyrocketed in the aftermath of Liz Truss’s disastrous mini-Budget, and remain elevated and volatile to this day. While they have now come down from their peak last summer when they weren’t far off 7%, rates remain significantly higher than those seen towards the end of the 2010s. 

Those who were at the beginning of a five-year fix when rates started going up won’t yet have rolled onto higher monthly costs. However, trade association UK Finance reports that around 1.6 million fixed-rate mortgages are due to expire at some point in 2024. If your mortgage is coming up for renewal soon, you could well be feeling nervous. 

As inflation continues to slow, interest rate cuts should be just around the corner. However, the base rate is unlikely to be cut dramatically at first. This means mortgage costs could remain elevated for some time. 

We share our tips on how to cope with higher mortgage costs

Katie Williams
Staff Writer

Katie has a background in investment writing and is interested in everything to do with personal finance and financial news. 

Before joining MoneyWeek, she worked as a content writer at Invesco, a global asset management firm, which she joined as a graduate in 2019. While there, she enjoyed translating complex topics into “easy to understand” stories. 

She studied English at the University of Cambridge and loves reading, writing and going to the theatre.