UK inflation surges to 3.5%, markets slash rate-cut bets

UK inflation accelerated sharply in April, reaching 3.5%, the highest since January 2024 and significantly surpassing market expectations and Bank of England (BoE) forecasts. The rise was mainly driven by higher energy and administered prices, including electricity, gas, and water bills. Inflation data released by the Office for National Statistics (ONS) also revealed notable upward pressure from transport costs, driven by new Vehicle Excise Duty on electric vehicles, and rising food prices.

Markets were quick to respond, dramatically reducing expectations for further BoE rate cuts this year. Investors now see just one more quarter-point reduction by year-end, down from previous bets for multiple cuts. The probability of an August rate cut dropped sharply from 60% to 40%, prompting the British pound to rise strongly, hitting $1.35, its strongest level since February 2022.

Persistent inflation pressures raise BoE caution

Of particular concern to the BoE was the jump in services inflation, which climbed to 5.4% from March’s 4.7%. This measure, closely watched by policymakers as an indicator of underlying inflation trends, exceeded the BoE’s expectations and highlighted ongoing inflationary pressures in the domestic economy.

Meanwhile, core inflation—excluding volatile food and energy—accelerated to 3.8%, the highest reading since April of last year. This stronger-than-anticipated core reading underscores the stickiness of inflation and suggests that underlying price pressures remain more entrenched than previously thought.

The data has notably shifted the narrative around BoE’s future moves. The Bank had already adopted a cautious stance in its last meeting, cutting rates to 4.25% in a split 5–4 vote. Two members argued for no rate cut, concerned that inflation was not yet sufficiently under control, while another two sought a deeper cut to 4%.

Following the latest data, economists have now lowered expectations for near-term easing. The figures probably rule out a June rate cut, and August reduction is now far from a done deal.

BoE Chief Economist Huw Pill echoed similar concerns this week, warning that interest rates might be falling “too quickly,” given the persistent underlying inflation trends.

Cost-of-living pressures return

The sharp monthly increase of 1.2% in consumer prices was the largest in two years, driven heavily by a 6.4% rise in the energy price cap, along with higher local authority taxes, water bills, and train fares. Additionally, the timing of Easter holidays notably increased volatility in services, particularly airfares, which soared 16.2% year-over-year.

The rising inflation coincides with fiscal tightening measures, including the introduction of a £26 billion payroll tax increase for employers and a near-7% minimum wage hike announced previously. Surveys indicate that businesses are increasingly likely to pass rising costs onto consumers, further exacerbating cost-of-living pressures.

Chancellor of the Exchequer Rachel Reeves expressed disappointment with the figures, acknowledging the renewed squeeze on household budgets amid broader economic uncertainty fueled by ongoing US tariff concerns and domestic policy changes.

The BoE expects inflation to peak around 3.7% by September, highlighting continued challenges for policymakers attempting to balance slowing economic growth with stubborn price increases.