April inflation "eases" but may be short-lived! UK May commodity prices accelerate but weak economy weakens urgency for rate hikes.

The British Retail Consortium said that supply disruptions and rising energy costs triggered by the Middle East war have led to an acceleration of commodity price inflation in the UK in May. A monthly survey of major chain retailers conducted by the BRC and released on Tuesday showed that in May, commodity prices rose by 1.2% compared to the previous year, higher than the 1.0% increase in April; furniture and health and beauty products saw the largest price increases, reflecting rising raw material and transportation costs. Food price inflation slowed from 3.1% to 2.7%, the lowest level in a year. At the same time, British retailers are urging the government to take more measures to help lower costs. Helen Dickinson, Chief Executive of the British Retail Consortium, said that the UK government, which had previously urged supermarkets to slow down price increases and at one point considered implementing price caps this month, must also play a role in reducing costs for retailers. Dickinson said, "Reducing non-commodity charges, taxes, and levies that make up more than two-thirds of energy bills, and reducing red tape, will help curb inflation." Although data released last week showed that favorable base effects and government measures to reduce energy bills in April resulted in the UK inflation rate falling to its lowest level in over a year, inflationary pressures are expected to rebound in the coming months. Data from the UK's Office for National Statistics showed that the Consumer Price Index (CPI) in April rose by 2.8% year-on-year, lower than the 3.3% in March, and below the 3% forecast by private sector economists and the Bank of England. The key indicator reflecting potential price pressures, service sector inflation, was at 3.2%, the lowest level since January 2022. As a result of the ongoing Middle East conflict, fuel costs in the UK have surged by 23%. However, with a policy that shifts the costs of green energy to general taxation coming into effect, household bills have decreased, partially offsetting the impact of rising oil prices. However, the inflation data for April is unlikely to provide much relief. Due to the UK's quarterly adjusted energy price cap mechanism, households in the UK face a lag in the impact of the Middle East conflict. This mechanism limits the rates that suppliers can charge typical households, and is expected to jump by 13% at the next adjustment in July. Gloomy outlook for the UK economy Economists warn that with the ongoing Middle East conflict and the increased likelihood of a new prime minister taking office, the UK's economic growth is now facing risks. Since the end of February when the US and Israel launched attacks on Iran, leading to the virtual closure of the Strait of Hormuz, a key global energy transport chokepoint, energy prices have risen significantly. In this context, the UK's economic growth prospects have weakened. A survey of economists conducted last month showed that the UK economy is expected to grow by 0.7% in 2026 and 1.2% in 2027. Both figures are below previous forecasts. The UK's energy structure is highly dependent on natural gas - the Middle East conflict has doubled the price of natural gas that the UK heavily relies on. While much of the natural gas is produced domestically in the UK, some still needs to be imported, and imported natural gas is much more expensive when priced in the market. Experts warn that gas and electricity costs for UK households are expected to rise by nearly 20% this summer, pushing the average bill in July to nearly 2000. Continuous energy shocks could further impact employment and increase the risk of an inflation feedback loop - as workers demand higher wages to compensate for losses, and businesses facing profit squeeze attempt to raise prices. Although evidence of such effects is still limited so far, as both workers and businesses lack bargaining power during periods of layoffs and weak demand. Most economists believe that the UK economy faces a high risk of stagflation. Survey data shows that the ongoing Middle East conflict is dragging down private sector activity. GlobalData reported that in April, businesses cited rising energy costs and weakening demand, exacerbating concerns in the market about "stagflation." The UK's Office for National Statistics also indicated that some consumer spending data for April showed "signs of weakening in the economy in the second quarter," with indicators of consumer demand slowing down. Data released last week also showed that UK retail sales in April fell by a larger-than-expected 1.3% compared to the previous month, marking the largest decline in nearly a year, as consumers cut back on spending and travel due to the energy shocks caused by the Middle East conflict. The labor market also showed signs of weakness. Data released by the UK's Office for National Statistics last week showed that after a 28,000 decrease in the number of taxpayers in March, a further 100,000 decreased in April. This figure was much higher than the expected decrease of 10,000 by economists, with the retail sector accounting for the largest share of job cuts. This indicates that as the Middle East conflict drives up energy costs and weakens business confidence, the demand for labor in the market is decreasing. However, the Office for National Statistics added that since the data covers the beginning of the new fiscal year, some employers' submission of reporting information may be incomplete, meaning that subsequent revisions may be larger than usual. Furthermore, political turmoil could also cast a shadow over the UK's economic outlook. In local elections held earlier this month, the ruling Labour Party led by Prime Minister Starmer suffered a heavy blow, with large numbers of MPs turning against him. Following the electoral defeat, Labour MPs have publicly called for Starmer to resign. Political instability could plunge the UK economy into trouble. The UK has a history of frequent changes in government, having replaced five prime ministers in seven years. Starmer, elected in July 2024, promised to focus on economic development. But hindered by multiple factors such as government tax policies, aging population trends, and persistent low productivity, the UK's economic growth has remained weak. The ongoing political turmoil further undermines investor confidence, casting a shadow over economic recovery. The Bank of England faces a dilemma Under the "squeeze of raising rates to curb inflation or lowering rates to stabilize growth" amid lingering inflation pressure and dim economic growth prospects, the Bank of England is in a policy dilemma. The Bank of England will announce its rate decision on June 18. The market currently expects the Bank of England to keep the base rate unchanged at 3.75%. The Bank of England maintained interest rates at the end of April, but the minutes of the meeting clearly indicated that several members who supported keeping rates unchanged hinted that they "might consider raising rates at future meetings." Several policymakers have warned that if energy prices do not rapidly fall, the financial environment "may need to tighten." Bank of England Governor Bailey said that in some of the more moderate scenarios the Bank of England was considering in regards to the economic impact of the Middle East conflict, rate increases may not be necessary to control inflation. However, he also issued a clear warning: "If energy supply continues to be severely disrupted, rates may need to be raised." In the worst-case scenario outlined by the Bank of England, assuming that oil prices remain around $130 and trigger substantial "second-round effects," models suggest that the interest rates needed to curb inflation would increase significantly, with rate increases ranging from 66 basis points to 151 basis points. However, the weak economic indicators presented by recent economic data have reduced the necessity for the Bank of England to raise rates in response to the Middle East situation. James Smith, economist at ING, stated, "The data suggests that there is insufficient basis for the Bank of England to raise rates. Sensitivity to rising energy prices triggering 'second-round' effects, such as wage growth, in the UK economy has significantly decreased compared to the last oil and gas crisis four years ago." Matthew Ryan, Head of Market Strategy at financial technology company Ebury, said in a report that following the weaker-than-expected UK inflation and employment data released last week, the Bank of England is unlikely to raise rates more than once this year. He said that the weakness in the labor market would act as a natural brake on second-round inflation effects, and the high UK government bond yields "are tightening financial conditions, and if combined with aggressive rate hikes, there is a risk of overcorrection." He added that the Bank of England may raise rates once in the summer. Evelyn Gomes-Letchi, Multi-Asset Strategist at Mizuho International, believes that although the inflation data is weak, the "green light has not yet been lit," and the market is not fully convinced. She expects the Bank of England to raise rates later this year, but the CPI and weak employment data have reduced the urgency.