Britain is bracing itself for further increases in borrowing costs as official data Wednesday showed inflation defied expectations of a slowdown, putting yet more pressure on the Bank of England a day before it is predicted to raise interest rates for the 13th time in a row to tame stubborn price growth.
Annual inflation, as measured by the consumer prices index, held steady at 8.7% in the year to May, the Office for National Statistics (ONS), against expectations for a modest decline to 8.4%, moving further away from October's 41-year high of 11.1%.
Markets increased their bets on further rate rises following Wednesday's figures, which showed underlying inflation rose to its highest since 1992.
The headline figure means British inflation is once again the fastest of any major advanced economy.
"After last month's fall, annual inflation was little changed in May and remains at a historically high level," said Office for National Statistics chief economist Grant Fitzner.
The numbers are also uncomfortable for Prime Minister Rishi Sunak – who has pledged to halve inflation over the course of this year before a probable 2024 election – and are likely to increase mortgage costs for millions of homeowners.
"May's CPI figures ratchet up the pressure on the Monetary Policy Committee to increase Bank Rate substantially further over the coming months," Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, said.
Sterling briefly jumped against the U.S. dollar and the euro after the figures were released and two-year government bond yields – which are sensitive to interest rate expectations – rose to their highest since July 2008.
Markets now see a 40% chance that the BoE will raise interest rates by half a percentage point to 5% on Thursday, rather than the quarter-point move previously expected. They see a 60% chance of rates reaching 6% by December.
Higher interest rates help lower inflation by making it more expensive for households and businesses to borrow, meaning they potentially spend less, thereby reducing upside demand pressure on prices.
"This makes a rate rise by the Bank of England this week near certain and materially increases the likelihood of further rises well into autumn," said Debapratim De, senior economist at Deloitte.
"Today's figures strengthen the case for the government to stick to its guns," Treasury chief Jeremy Hunt told reporters.
"If you look at what's happening in other countries, you can see that rises in interest rates do bring down inflation over time, that will happen here," he added.
British inflation started to pick up in 2021, when many economies faced supply-chain bottlenecks as they emerged from the COVID-19 pandemic, and accelerated sharply after Russia invaded Ukraine in February 2022, sending natural gas prices soaring across Europe.
Inflation has been slower to fall in Britain than elsewhere, however, partly due to the timing of energy subsidies, but increasingly too as a result of big price rises apparently becoming embedded across swathes of the economy.
The Office for National Statistics said core inflation – a measure that excludes volatile food, energy, alcohol and tobacco prices, and which the BoE views as a good guide to underlying price pressures – unexpectedly rose to 7.1% from 6.8%, its highest since March 1992.
Another measure of underlying pressures, services price inflation, which is heavily influenced by fast-rising wages and Britain's tight post-pandemic job market – also reached its highest since 1992 at 7.4%.
"The cost of airfares rose by more than a year ago and is at a higher level than usual for May," ONS's Fitzner said. "Rising prices for second-hand cars, live music events and computer games also contributed to inflation remaining high."
Food and drink price inflation dropped slightly to 18.3% from April's 19%.
Paul Dales, chief U.K. economist at Capital Economics, said he now forecast that the BoE would raise interest rates by half a percentage point on Thursday after the latest numbers.
"The problem is that the recent surge in core inflation and the re-acceleration in wage growth shows that domestic inflationary pressures are still strengthening. This suggests the Bank may have more work to do than the Fed or ECB," Dales said.
The anticipated increase in interest rates will pile further pressure on financial institutions to increase their own lending rates for loans and mortgages.
Many homeowners will be cushioned from the recent increases as they fixed their mortgages when interest rates were ultra-low during the coronavirus pandemic. However, those whose fixed-rate terms expire over the coming months will face much higher borrowing rates when they look to lock in new deals.
"It's a ticking time bomb as 1.4 million borrowers will see an end to their low fixed rates this year," said Jamie Elvin, director at mortgage broker Strive Mortgages.
Unlike the United States, where many homeowners fix their mortgage rates for 30 years, the prevailing habit in the U.K. is for homeowners to fix a rate for much shorter periods of time, after which they move to their lender's usually higher variable rate or seek out other deals. In the current climate, for example, those who fixed their mortgage rate at below 1% three years ago may see a fivefold increase in their rates.
Last month the BoE forecast inflation would drop to just over 5% in the final quarter of this year and fall below its 2% target in early 2025.
There may be some relief on the horizon, however, as producer price inflation slowed much more sharply than economists had expected.
Prices charged by manufacturers rose by 2.9% in the 12 months to May, down from an increase of 5.2% in April and the smallest rise since March 2021.
