UK inflation unexpectedly remained stable in May, recording 2.8% year-on-year, which is below economists’ forecasts. This indicates weaker price pressures, even before a U.S. deal to end the war in Iran led to a drop in energy prices.
Consumer prices rose by 2.8% compared to last year, unchanged from April, the Office for National Statistics (ONS) reported on Wednesday. This figure was lower than economists’ expectations, which had predicted inflation would rise to 3%. According to the ONS, inflation was tempered by a decline in food costs, particularly for meat and dairy products, which offset price pressures from airfares, vehicle taxes, and gasoline.
Service sector pressures and market reactions
At the same time, price growth in the service sector, which is closely monitored for domestic pressures, rose to 3.7%, exceeding forecasts. These data seem to support the “wait and see” approach favored by some members of the Bank of England’s (BOE) Monetary Policy Committee, who are meeting this week.
The current situation unfolds against a backdrop of data indicating a “dovish” trend, including further weakening in the labor market and a slowdown in growth following a strong start to 2026. After the release of consumer price index (CPI) data, UK government bonds (gilts) rose, and traders reduced their bets on rate hikes, pricing in only one increase by the end of the year.
Impact of Middle Eastern deal and upcoming events
Markets expect rates to remain at 3.75% on Thursday. According to Paul Dale, chief economist for Capital Economics in the UK, the current situation “may give the Bank of England more confidence that it does not need to raise interest rates tomorrow, or at all”. He added that inflation is expected to return to the BOE’s target of 2% next year.
The deal to end the conflict in the Middle East, which includes the reopening of the Strait of Hormuz, has raised questions about the need for any rate hikes at all. This agreement has led to a drop in energy prices in the markets and increased hopes of controlling any inflationary impacts.
The price of Brent crude oil fell below $80 per barrel for the first time in more than three months. This sharp decline in prices is expected to lead to lower gasoline prices. Investors will closely monitor key events tomorrow, including new labor market data, the BOE meeting, and special elections, the results of which will be announced on Friday and could see Greater Manchester Mayor Andy Burnham return to Parliament, where he may challenge Prime Minister Keir Starmer.
Source: Bloomberg