Data from the retail sector indicates that price inflation for goods in the UK accelerated in May, influenced by supply disruptions and rising energy costs linked to the Middle East conflict. A monthly survey of major retail chains released on Tuesday showed that goods prices in May increased by 1.2% compared to the same period last year, up from a 1.0% rise in April. Furniture, along with health and beauty products, recorded the most significant price increases, reflecting higher costs for raw materials and transportation. Meanwhile, food price inflation decelerated to 2.7% from 3.1%, marking its lowest level in a year.
Concurrently, retailers are calling for more government action to help reduce costs. The chief executive of the retail association stated that the government, which had previously urged supermarkets to slow price increases and had considered implementing price caps this month, must also play a role in lowering costs for retailers. She suggested that reducing non-commodity charges, levies, and surcharges—which constitute over two-thirds of energy bills—and cutting red tape would help curb inflation.
Although data released last week showed that UK inflation in April fell to its lowest level in over a year, aided by favorable base effects from the previous year and government measures to reduce energy bills, price pressures are anticipated to rebound in the coming months. Official statistics indicated that the Consumer Price Index rose by 2.8% year-on-year in April, down from 3.3% in March and below the 3% forecast by private sector economists and the central bank. A key measure of underlying price pressures, services inflation, was 3.2%, the lowest since January 2022. Fuel costs surged by 23%, impacted by the ongoing Middle East conflict. However, household bills decreased, partly offsetting the impact of rising oil prices, as a policy shifting green energy costs to general taxation took effect.
Nevertheless, the April inflation data is unlikely to provide much sustained relief. Due to the UK's quarterly energy price cap adjustment mechanism, households face a lag in experiencing the full impact of the Middle East conflict. This cap limits the rates suppliers can charge a typical household and is projected to jump by 13% in the next adjustment scheduled for July.
The UK's economic outlook appears challenging. Economists warn that growth is now at risk due to the unresolved Middle East conflict and the increased possibility of a new prime minister taking office. Energy prices have risen significantly since late February, following attacks that nearly closed a critical global energy shipping route. Under this scenario, the UK's growth prospects have weakened. A recent survey of economists indicated that the UK economy is now expected to grow by 0.7% in 2026 and 1.2% in 2027, both figures lower than previous forecasts.
The UK's energy mix is heavily reliant on natural gas. The conflict has doubled the price of gas, which the UK heavily depends upon. While much gas is produced domestically, some is imported at market prices, which are substantially higher. Experts warn that household gas and electricity costs could rise by nearly 20% this summer, pushing the average July bill close to £2,000. Persistent energy shocks could further impact growth and employment, while also increasing the risk of an inflationary feedback loop, as workers may demand higher wages to compensate, and profit-squeezed businesses may attempt to raise prices. Evidence of such effects has been limited so far, as neither employees nor firms have significant bargaining power during a period of layoffs and fragile demand.
Most economists view the risk of stagflation in the UK as elevated. Survey data shows that the Middle East conflict continues to weigh on private sector activity. Business reports from April indicated soaring energy costs and weakening demand, heightening stagflation concerns. Official statistics also noted that some consumer spending data for April showed "some signs of weakness entering the second quarter," with indicators of consumer demand slowing. Data released last week showed that UK retail sales fell by a larger-than-expected 1.3% month-on-month in April, the largest drop in nearly a year, as energy shocks from the conflict led consumers to cut spending and reduce driving.
The labor market is also showing signs of weakness. Data showed that the number of tax-paying employees fell sharply by 100,000 in April, following a decrease of 28,000 in March. This figure was much higher than the expected drop of 10,000, with retail job cuts accounting for the largest share. This suggests demand for labor is weakening as the conflict pushes up energy costs and dampens business confidence. However, it was noted that due to the start of a new fiscal year, some employer submissions might be incomplete, so subsequent revisions could be larger than usual.
Furthermore, political turbulence could cloud the UK's economic outlook. In local elections held earlier this month, the ruling party suffered a significant defeat, with a large number of its members of parliament defecting. Following the electoral setback, party members have publicly called for the prime minister's resignation. Political instability could potentially push the economy into difficulty. The UK has already experienced frequent leadership changes, with five different prime ministers in seven years. The current prime minister, elected in July 2024, pledged to focus on economic development. However, UK growth has remained sluggish, hampered by factors including government tax increases, an aging population, and persistently low productivity. Ongoing political turmoil further weakens investor confidence, casting a shadow over economic recovery.
Caught between persistent inflationary pressures and a dim growth outlook, the central bank faces a policy dilemma: raising rates to curb inflation or cutting rates to stabilize growth. The central bank's next interest rate decision is scheduled for June 18. Markets currently expect it to keep the base rate unchanged at 3.75%. At the end of April, the bank held rates steady, but meeting minutes indicated that several members who supported holding rates suggested they "might consider raising rates at future meetings." Several policymakers warned that if energy prices do not fall quickly, financial conditions "may need to tighten."
The central bank governor stated that in some of the milder economic impact scenarios from the Middle East conflict being considered, rate hikes might not be necessary to control inflation. However, he also issued a clear warning: "If energy supplies face severe and sustained disruption, interest rates may need to be increased." In the bank's worst-case scenario, assuming oil prices remain around $130 and trigger substantial "second-round effects," models suggest the required interest rate to suppress inflation would rise significantly, with hikes ranging between 66 and 151 basis points.
However, recent economic data showing signs of economic weakness have diminished the urgency for the central bank to hike rates due to the Middle East situation. An economist stated, "Various data points suggest there is already insufficient justification for the central bank to raise rates. Compared to the last major oil and gas crisis four years ago, the UK economy's sensitivity to 'second-round' effects from energy price hikes, such as on wage growth, is now much lower." A market strategist noted that following last week's weaker-than-expected UK inflation and jobs data, the central bank is unlikely to raise rates more than once this year. He added that labor market weakness should act as a natural brake on second-round inflation effects, and high government bond yields are "already tightening financial conditions; adding aggressive rate hikes on top risks overcorrecting." He suggested the central bank might hike once over the summer.
Another analyst argued that despite softer inflation data, a "green light" has not yet been given, and markets are not fully convinced. The central bank is still expected to raise rates within the year, but the CPI data and weak employment figures have reduced the immediacy.
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