Inflation sees bigger-than-expected drop to 2.8% - but is it an outlier?

UK CPI inflation fell to 2.8% in the year to April, down from 3.3% in March and 0.2% lower than economists expected.

The reduction in the energy price cap in April was a key driver behind the slowdown, while elevated fuel prices continued to keep inflation above the 2% target.

Despite the surprise ease in inflation, industry experts say the fall is unlikely to be sustained, with signs inflation could pick up again through the summer. 

Rising global energy costs, driven by the ongoing conflict in Iran, are expected to feed through into a higher Ofgem price cap from 1st July.

Luke Bartholomew, deputy chief economist, at Aberdeen, said: “Inflation coming in softer than expected today will further take the pressure off the Bank of England to hike rates over the next few meetings. But we are most certainly not out of the woods in terms of the impact of the Iran conflict on inflation. 

"Ironically, this is probably the month inflation would have been back at the 2% target were it not for the Iran war. Instead, headline inflation will pick-up again in coming months, especially after the next energy price cap re-set in July. So as inflation climbs back towards 3.5% later this year, the question of interest rate hikes will remain pressing. But on balance, we think the weakness of the economy, and the labour market in particular, will stay the Bank’s hand, with rates remaining on hold even as inflation pressures remain elevated.” 

Jeremy Batstone-Carr, European Strategist at Raymond James Wealth Management, commented: “The growing impact of the conflict in and around the Persian Gulf has taken the gloss off an expected sharp drop in consumer price pressures prior to the onset of hostilities at the end of February. Last year’s minimum wage hike, coupled with regulatory price hikes dropping out of the Office for National Statistics yearly calculations, meant that consumer price inflation eased, but to a far lesser extent than anticipated just a few months ago. 

“Headline consumer prices increased by 0.9% last month, almost entirely due to surging fuel and heating oil prices. This was, in part, offset by the impact of Ofgem’s pre-announced 6.7% (month-on-month) fall in its utility price cap which, combined with residual effects from an early Easter and last year’s price hikes dropping out of the yearly calculation, resulted in headline price increases dropping from 3.3% in March to 3.0% last month. 

“But today’s confirmation that consumer price pressures eased in April will provide only temporary respite. Contemporary business surveys point to rising input and output prices, the clear consequence of the ongoing energy price shock. While the data confirms only limited pass-through impact so far, the Bank of England will be very much on its guard for signs that inflation expectations are rising. In addition, a softening labour market limits the scope for second round effects in the form of higher wages for now. There is also confirmation that the energy regulator stands ready to raise its utility price cap in both early July and October which will see price pressures intensify as the year progresses. 

“Rate-setters on the Bank’s MPC have a few more weeks before they convene to debate monetary policy, but the minutes following last month’s meeting confirmed that members’ views were far less emphatic than the 8-1 vote to keep the base rate unchanged at 3.75% appeared. While senior officials may still feel that an “insurance” rate hike is the best way forward against a highly uncertain backdrop, everything will hinge on the evolution of events in the Middle East.” 

Derrick Dunne, CEO of YOU Asset Management, added: “The drop in inflation is really welcome, especially given yesterday’s slowing labour market and wage data from the ONS. But these figures should be treated with some caution. It is highly possible that inflation will pick back up from here thanks to the renewed energy price shock. 

“This shock is only set to worsen in the Summer with forecasts that the next Ofgem energy price cap will have to soar by 13% or £209 on average to account for changes in energy prices since the onset of the crisis in the Middle East. This will be a huge blow for households already struggling with cost-of-living pressures and will directly feed back into higher inflation.

“In the short term for now, this could provide some relief to interest rate expectations as inflation concerns are the primary driver of higher market rates, even if the Bank of England has taken a ‘wait and see’ approach. Given the bigger than expected fall in inflation today, this approach might seem vindicated – but much is still unclear."