UK inflation drops, but for how long, as Reeves tries to impose price caps on food

The UK’s inflation rate softened in April, with headline prices rising at a 2.8% annual rate, down from 3.3% in March. The core rate of inflation also moderated to 2.5% from 3.1%. While a moderation in price growth for April was expected, UK price growth undershot low expectations. Why? This is all down to the temporary reduction in  the energy price cap, and housing and household services, notably electricity and gas prices, which made the largest downward contribution to the CPI index.

There were also declines in prices for recreation  and culture, food prices, and health related costs were all lower. On the opposite scale, clothing and footwear prices rose at the fastest rate last month. The ONS, who compile the CPI figures, confirmed that lower electricity and gas prices were due to the government’s support package, which reduced variable and fixed rate tariffs, along with the effect of lower wholesale prices before the Middle East war, which meant that the Ofgem price cap was lowered last month. The ONS added that price declines for electricity and gas were only partially offset by a further increase in petrol and diesel costs last month.

The decline in the food price index last month is also interesting, especially as Rachel Reeves is urging price caps for essentials at supermarkets. Lower chocolate and meat prices helped to weigh on the food index. Today’s data could give the supermarkets ammunition to push back on Reeves’ request for them to lower prices even more.

While analysts have focused on the price increases linked to the Iran war, package holidays are falling in price, as the war unsettles travel plans. Stories of jet fuel shortages and the risk of getting stranded at your destination, could fuel holidaymaker caution this year, and staycations are starting to look more attractive than the traditional two-weeks in the sun. We could see holiday prices remain under pressure until the war ends.

Why lower inflation might not last

The Bank of England expected the lower energy price cap to reduce inflation in late spring, before it picks up again later in the summer. The Ofgem price cap is likely to be lifted in July, and this will reflect the higher wholesales prices for gas and electricity, which will add upward pressure on the UK’s inflation rate in the coming months. Added to this, petrol prices hit their highest level since the war began on Tuesday, and the average price of a litre of unleaded petrol is now 158.2p.

UK lifts sanctions on Russian oil to quash price rises

Reeves is putting pressure on supermarkets, and this morning the government announced that it was lifting sanctions on Russian oil that is refined in different countries. This means that the UK can now import jet fuel from India that originates from Russia, and restrictions on LNG supplies from Russia have also been eased. This is a spectacular U-turn from the government, especially after the G7 group of nations, including the UK, had agreed to a wave of new sanctions on Russia earlier on Tuesday.

The market impact from this news has been minimal. Brent crude remains above $110 per barrel, even though the oil price has been falling in the last 24 hours. This suggests that we could remain above this key level until the Strait of Hormuz is fully reopen.

The pound is down a touch on the back of the weaker than expected CPI data. GBP/USD is back below $1.34 and is trading at $1.3390, however, FX moves have been small so far. Today’s data puts to bed the idea that there will be a rate hike at the Bank of England’s June meeting. Whether or not global central banks will hike rates depends on the outcome of peace negotiations between Iran and the US, and the reopening of the Strait of Hormuz in the coming weeks.

Rachel Reeves goes rogue and suggests price caps in supermarkets

Ahead of the CPI release, the market was digesting news that the UK government is asking supermarkets to freeze the price of essential items like eggs, bread and milk in an attempt to limit the inflationary impact from the war in Iran. This is a highly unusual move, and the focus will be on UK supermarkets at the start of trading on Wednesday, including Tesco, Sainsburys and Marks & Spencer. The government is hoping to arrange a quid pro quo with food retailers and incentivize them to freeze prices in exchange for lifting regulations on packaging and healthy food, such as pausing the introduction to anti-obesity regulations.

In Scotland, the government is trying to force price caps on food with legislation, the same is unlikely to happen in England, but this news has still angered supermarkets, who blame the government for failing in its growth agenda and instead interfering in its business model.

It is worth noting that the UK has some of the most affordable grocery prices in Western Europe, according to the British Retail Consortium, due to strong competition in the sector. Traditionally, price caps lead to reduced supply, which can ultimately push up prices. This is a risky move from an embattled government, and it could ignite the ire of voters even more if it backfires.

Chancellor Rachel Reeves is expected to formally announce the pause in lifting fuel duty by 5p this September, however, price caps at supermarkets are not expected to be included in her cost of living plan. If Reeves is too generous in her support of households, then this could weigh on Gilts even more and send yields higher. UK 10-year Gilt yields rose by 6bps on Tuesday. This was part of a global bond market sell off on Tuesday, but UK yields are considered particularly vulnerable. Thus, any signs of unorthodox economic policy could spook the bond market later today.