(Bloomberg) -- British inflation fell back to the Bank of England’s 2% target for the first time in almost three years, a milestone that likely comes too late to improve the political fortunes of Prime Minister Rishi Sunak before the looming election.

Consumer price increases eased in May from 2.3% the month before, the Office for National Statistics said on Wednesday. Those figures should keep the central bank on track to cut interest rates in the coming months, even though Bank of England officials have signaled they are unlikely to announce a policy shift on Thursday due to the election campaign. 

The slowdown in price rises has allowed Sunak to declare victory over a brutal cost-of-living squeeze, after inflation reached double digits in 2022 because of Russia’s war in Ukraine and the end of pandemic restrictions. The decrease is unlikely to be enough to help the ruling Conservative Party, which polls show is heading for defeat to Labour in the July 4 election.

BOE policymakers may appreciate the extra month to weigh lingering signs of sticky prices beyond the headline rate. Inflation in the services sector remained higher than expected, registering a 5.7% gain last month after a reading of 5.9% in April. Economists had expected a sharper decline to 5.5%. Forecasters suggest headline inflation rate will pick up to 2.4% by the end of the year.

The ONS said that prices in restaurants and hotels contributed most to the headline rate with the sector passing on demands for higher pay, not least after the rise in the minimum wage. Rent and fuel costs also were upward forces on services.

“Inflation may be back at 2%, but it might not be there for long,” said Zara Nokes, global market analyst at JPMorgan Asset Management. “Today’s inflation news puts the final nail in the coffin for any hopes of a rate cut from the Bank of England tomorrow. Services inflation is still running too hot.”

What Bloomberg Economics Says ...

“Another stronger-than-expected services inflation reading will make for uncomfortable reading for the Bank of England and is likely to make it cautious about how quickly it eases monetary policy this year. We still think the fall in headline inflation to 2% warrants a cut over the summer – probably in August. But beyond that, ongoing signs of persistence justifies a slower pace of cuts.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT. 

The pound erased modest losses after the release showed UK services inflation fell less than expected, denting expectations for rate cuts. Sterling traded as much as 0.2% stronger at $1.2730. Traders priced chances of a quarter-point reduction in August at about 30%, down from 45% before the data.

The figures also leave the UK, which last year had the worst inflation problem among its major peers, now looking like a leader on suppressing price pressures. Only the US also has inflation at 2% on a comparable measure, though its headline rate is higher.

“The UK has won the international race to get back to target, being the first among the euro area and US to bring headline inflation back down to 2%,” the Resolution Foundation said. “In fact, the UK currently has the lowest headline inflation rate in the G-7 bar Italy.”

Soaring prices and last year’s recession took a bite out of the Conservatives’ reputation for managing the economy. Politicians seized on the figures, with Sunak hailing, “great news” that inflation is “back to normal at 2% — that’s lower than Germany, France and America.” 

Labour’s Shadow Chancellor Rachel Reeves said, “I’m not going to say that everything is fine. For many families and pensioners, the cost of living crisis is still acute because although although inflation is falling, that doesn’t mean prices are going down it just means they’re going up at a lower rate.”

Policy makers at the BOE led by Governor Andrew Bailey remain on guard for signs that inflation will persist and are watching wages and price-setting in services before loosening policy.

Goods prices fell 1.3% on the month, the most since 2016. Annual food inflation — one of the major drivers of the double-digit price increases — eased to 1.6% and dragged the overall rate lower. Some products are now seeing declines in prices, such as fish and dairy.

“Services prices may be a little stickier than anticipated,” said Sanjay Raja, chief UK economist at Deutsche Bank Research. “This, we think, will raise the bar for an August rate cut.”

Why Aren’t UK Interest Rates Falling With Inflation?: QuickTake

Investors and economists expect the BOE to leave the benchmark rate at a 16-year high of 5.25% on Thursday when the next decision is released. Rate setters have refrained from public remarks during the election campaign, but they previously expressed concern about indicators of underlying inflation.

“Another fall in inflation in May will come as welcome news to households as we move towards a more benign inflationary environment,” said Martin Sartorius, principal economist at the CBI. “However, many will still be feeling the pinch due to the level of prices being far higher than in previous years, particularly for food and energy bills.”  

Separate figures showed pipeline inflation pressures remained subdued, with producer input prices falling falling 0.1% from a year earlier and output prices rising 1.7%. The figures are down sharply from their peak levels in 2022.

“While this is positive news, we expect to see inflation rebound somewhat from June onwards,” said Paula Bejarano Carbo, economist at the National Institute of Economic and Social Research.

--With assistance from Harumi Ichikura, Andrew Atkinson and Constantine Courcoulas.

(Updates market reaction.)

©2024 Bloomberg L.P.