UK Inflation Rate: How Fast Are Prices Increasing?

In May 2024, the UK’s inflation rate reached 2%, down from 2.3% in April, marking the lowest rate in nearly three years. This decrease means inflation has finally hit the Bank of England’s 2% target. Despite this achievement, the Bank has opted to keep interest rates steady at 5.25% for the seventh consecutive time, maintaining them at their highest level in 16 years.

What Does Inflation Mean?

Inflation represents the increase in the price of goods and services over time. For instance, if a bottle of milk costs £1 today and £1.05 a year later, the annual milk inflation rate is 5%.

Measuring the UK’s Inflation Rate

The Office for National Statistics (ONS) measures the UK’s inflation rate by tracking the prices of hundreds of everyday items, including food and fuel. This “basket of goods” is regularly updated to reflect current shopping trends. In 2024, vinyl records and air fryers were added to the basket, while hand sanitiser was removed.

The ONS calculates inflation using the Consumer Prices Index (CPI), which tracks price changes over the previous 12 months. In May, the CPI fell due to a slowdown in price rises across several categories, including food and soft drinks, recreation and cultural activities, and furniture and household goods.

Why Are Prices Still Rising?

While inflation has significantly decreased from its peak of 11.1% in October 2022, prices are still rising, albeit at a slower rate. High energy and food prices have kept inflation above the Bank of England’s target for some time. Food prices remain 25% higher than at the beginning of 2022, and petrol prices are once again on the rise. Additionally, worker shortages have increased the cost of hiring and retaining staff.

The inflation spike in 2022 was driven by increased demand for oil and gas following the Covid-19 pandemic and further exacerbated by the surge in energy prices after Russia’s invasion of Ukraine.

The Impact of Interest Rates on Inflation

The Bank of England uses interest rates as a tool to manage inflation. By raising interest rates to 5.25% when inflation was well above the target, the Bank aimed to reduce spending and slow price increases. Higher interest rates make borrowing more expensive, encouraging people to save more and spend less, which in turn reduces demand for goods and services.

However, this strategy is a balancing act. Increased borrowing costs can negatively impact the economy by raising mortgage repayments for homeowners and reducing business investments and job creation.

Future of Inflation and Interest Rates

Despite the CPI reaching the 2% target, the Bank of England decided to keep interest rates at 5.25% because it believes inflation has not decreased sufficiently. The Bank considers other inflation measures, such as core inflation, which excludes volatile food and energy prices. In May, core inflation was 3.5%, indicating that underlying price pressures remain. Additionally, prices in the service sector increased by 5.7%.

Most economists now anticipate a rate cut in the autumn rather than the summer. The Bank of England’s next interest rate meeting is scheduled for 1 August, with June’s inflation figures set to be released on 17 July.

Wages vs. Inflation

Wages in the UK are currently rising faster than prices. Between February and April 2024, average pay (excluding bonuses) increased by 6% compared to the same period in 2023. When adjusted for inflation, real pay rose by 2.9%.

Inflation and Interest Rates Globally

The UK is not alone in experiencing inflation and higher interest rates. In the eurozone, inflation was 2.6% in May, up from 2.4% in April. In June, the European Central Bank cut its main interest rate from an all-time high of 4% to 3.75%, marking its first reduction in five years.

In the US, inflation fell to 3.3% in the year to May, down from 3.4% in April. The US central bank has kept its key interest rates between 5.25% and 5.5% since July 2023 and signaled a potential rate cut later in 2024.

The UK has successfully brought its inflation rate down to the Bank of England’s target of 2%, but underlying price pressures and high core inflation indicate that the fight against inflation is not over. As policymakers balance the need to control inflation with the potential economic impact of high interest rates, the future direction of monetary policy will depend heavily on upcoming economic data.