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UK inflation hits Bank of England target, but don’t expect a rate cut tomorrow 

After nearly three years above the Bank of England’s 2% target, UK CPI fell to 2% in May as food prices fall.

Rishi Sunak is, of course, claiming credit for the drop in inflation. However, in reality, inflation dropping back to 2% was always going to happen, and prices are still far higher than they used to be.

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The inflation rate falling back to the BoE’s target will do little to boost his standing with voters, as the prices of some everyday items are still 30%—50% higher than they were three years ago. Prices are falling but from a very high level.

“Food prices actually fell in May, with the price of essentials like bread, cereals, vegetables and even chocolate dropping,” said Laura Suter, director of personal finance at AJ Bell.

“This month’s fall compares to a chunky rise in food costs a year ago, which helped to pull the inflation rate back down. However, we’re still paying more for food and drink than we were a year ago – and the overall food basket is still much more expensive than at the start of the cost of living crisis.”

The general sluggish environment for UK growth would also have helped temper inflation – although this isn’t the ideal remedy and has done Conservatives more harm than good.

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From the markets perspective, and implication’s for tomorrow’s BoE rate decision, today’s inflation reading was a bit of a non event. 

The FTSE 100 fell and bond yields barely budged. The pound spiked against the dollar as traders reacted to the low chance of a rate cut tomorrow.

“Inflation hitting target means many will be expecting a cut to interest rates at the Bank’s meeting tomorrow. However, it would be very unlikely for the ratesetters to cut interest rates during an election campaign. The future path for inflation – and so rates – will be impacted by whoever becomes prime minister and how their fiscal policy shapes up. It’s highly likely the Bank will want to wait to see the outcome of the election and the final economic plans before making that first cut,” Suter said.

“With no meeting in July, that means all eyes are now firmly on the August MPC meeting for our first potential cut to rates.” 

Ratesetters will likely already have made up their minds on how they will vote and one month of inflation back at target doesn’t mean we are completely out of the woods. The Bank of England doesn’t want to risk cutting rates too early and will want to see inflation stabilise at current levels before acting.

That said, a rate cut at teh August meeting is now very much on the cards. 

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