UK inflation fall eases prospect of imminent rate hike

Inflation in Britain dipped in May as transport costs returned to normal following an Easter-related boost, official figures showed Wednesday, likely easing the pressure on the Bank of England to raise interest rates this summer.

The Office for National Statistics said Wednesday that consumer prices were up 2% in the year to May, compared with 2.1% the previous month. It highlighted a sharp decline in transport-related inflation.

The fall means inflation is back at the Bank of England's target of 2% and cements market expectations that the Bank of England won't raise interest rates on Thursday. In recent weeks, policymakers have signaled that they are inclined to look past Brexit-related economic uncertainties and raise interest rates again — in contrast to the U.S. Federal Reserve and the European Central Bank, which have pointed to rat cuts.

Bank of England rate-setters have voiced concerns that a lack of spare capacity in the economy — it's still growing, with unemployment at 45-year lows — and wage increases will stoke inflation.

However, with oil prices falling sharply in recent weeks, economists think inflation will fall further in coming months. As a result, few in the markets expect the central bank to increase its main interest rate from the current 0.75% on Thursday or even at its subsequent meeting in August.

The bank thinks wage pressures are likely to continue to build due to skills shortages and, as such, the Monetary Policy Committee's interest rate statement on Thursday is expected to warn about the risks of inflation.

"Policymakers have been keen to highlight that they believe market expectations of interest rates are too low, and it's possible we see more explicit references to this in either tomorrow's statement or accompanying minutes," said James Smith, developed markets economist at ING.

When rates move — up or down — will largely depend on what happens on the Brexit front. Britain is due to leave the European Union on Oct. 31 and some of the Conservative Party candidates running to replace Prime Minister Theresa May have said they are prepared to leave on that date with no deal with the EU. Others have indicated they are prepared to back a delay.

As a result, there are big uncertainties surrounding the economic outlook and the path of interest rates. Even Brexit supporters say a 'no-deal' Brexit will lead to "economic disruption."

Most economists think it would cause a deep recession as Britain's relationship with its most important partner is seriously impacted, through tariffs and other disruption to trade. Inflation is also widely tipped to rise sharply because of tariffs on EU imports and because the pound would likely fall, further pushing up the cost of imports.

As such, Bank of England Governor Mark Carney has warned that interest rates could go either way in the event of a 'no-deal' Brexit.

If Britain reaches a Brexit deal that smooths out its exit or Brexit is abandoned, then interest rates would be more likely to rise.

But even then, the case may not be as clear-cut as it is now.

"The other major central banks are already looking down — not up," said Stefan Koopman, senior market economist at Rabobank International.

"The global economy hit a real soft patch, and whilst we may see a recovery, we're unlikely to see a return to the buoyant growth rates of 2017-early 2018."