UK service prices falter, but food remains elevated, as Trump holds the cards for the oil price

UK price growth moderated as expected last month, but core prices fell more than headline price growth, and service prices moderated to a 4.7% annual rate, down from a 5.4% rate.

Airfares weigh on inflation

There were downward contributions to the CPI rate from four divisions, including transport, communication services, housing and household services and alcohol and tobacco prices. Five divisions contributed positively to CPI including recreation and culture, clothing and footwear, furniture and household goods, and food. Housing inflation continues to rise in the UK, and housing prices rose nearly 1% in the 12 months to May.

Food prices keep CPI elevated

Air fares fell last month, along with motor fuel, which added to the downside pressure on inflation in May. However, rising prices for food and household appliances meant that headline inflation did not fall as much as expected, and only inched lower to a 3.4% annual rate from a 3.5% annual rate.

Service prices might have peaked

This is an interesting shift going on in the inflation data: the price of services is moderating, at the same time as the price of goods is rising. Whereas service price inflation has been supported in recent years as consumers rushed to have experiences – foreign holidays and eating out – there are signs that the tables might be turning, and consumers in the UK might be scaling back on the experiences and focusing more on buying ‘stuff’. The CPI goods annual rate rose to 2% from 1.7% in April, the highest level since November 2023, while the CPI services annual rate moderated to 4.7%, down from 5.4%.  This shift could be a sign that service price growth might have peaked, which would make it easier for the        BOE to cut interest rates.

The ONS also adjusted prices for May, due to an error in the calculation in the vehicle excise duty component. This error has overstated inflation in the past. The correction is only reflected in the May figures. This had a small downward impact on inflation in May, but it asks more questions about the accuracy of ONS statistics.

The market reaction

The pound is rising on the back of the higher-than-expected reading for headline CPI. GBP/USD is recouping some of its recent losses and is back above $1.3450. The pound is also getting a helping hand from a weaker dollar. UK Gilts are underperforming their European counterparts in the sovereign bond market this morning, although gains for Gilt yields are moderate so far, as we wait for Thursday’s BOE meeting.

The FTSE 100 is predicted to open up more than 0.25%, although the UK’s blue-chip index is driven more by the geopolitical tension and movement in the oil price than inflation or what the BOE will do next. For example, the increase in the oil price in the past 5 days has boosted BP’s share price. It has risen nearly 5% in the past 5 sessions and is now only lower by 1.5% YTD.

Trump to determine where oil prices go next

President Trump left investors guessing about whether the US will attack Iran on Tuesday. Oil prices rose; however, they have since given up some gains and Brent is back below $76 per barrel. We expect the oil price to continue to rise when Trump suggests that the US will attack Iran, but oil prices could fall if the attack does not materialize. This is the pattern for oil prices this week, and we need to get used to it. A bit like tariffs, Trump holds the oil market in suspense.

The trend higher in the oil price is obvious, but the reaction in the spot market has been muted so far, Brent crude is higher by $8 since the conflict began. Gains for the oil price might seem muted so far due to the gravity of the situation, however, while the spot price is only moderately higher, the options market has seen fevered activity. Demand for calls in Brent crude oil has surged, while demand for puts has fallen. This suggests that the market is willing to hedge against another surge in the oil price, in case Trump is true to his word.

Federal Reserve: no change in stance expected, but watch the Dot Plot

The Fed meeting this evening is the other main event. We will be covering this live later tonight. As we lead up to the meeting, US stock futures are slightly higher, bond yields are moderately higher, and the interest rate futures market is still pricing in zero chance of a cut this evening, with two rate cuts currently expected for this year. Since the Fed is not expected to cut rates at this meeting, the focus is likely to be on the Dot Plot and whether the market is correct to price in 2 rate cuts.