23 May 2025

Jonathan Sparks

Chief Investment Officer, UK, HSBC Global Private Banking and Wealth

Dig deep enough and you can always write-off surprises to inflation as a one-off here or a seasonal spike there. Inflation is measured as a basket of goods and services, but prices within this basket can move in fits and starts. Yesterday’s April CPI inflation jump to 3.5% beat more of the consensus expectations, with a 1.2% monthly jump. More worryingly, services inflation bucked the downward trend by jumping to 5.4% from 4.7%.

In April’s inflation, water bills and energy took the brunt of the blame. The Ofgem energy price cap rose by 6.4% year-on-year, while water supply and sewage collection leapt by an eye-watering 26.1% over just one month. Higher water prices thanks to a need to update creaking infrastructure can hardly be put down to overwhelming demand. Dig deeper and the timing of Easter can be blamed for a 27.5% rise in air fares, or you could point to a hike in the road tax.

This means it’s tempting to write April’s inflation off as a one-off that should be “looked through” by the Bank of England. While this is sometimes the right approach, particularly in the case of a shock where it will take a little time to see how households adjust their spending, the current situation is more complicated.

Even if we take all the above out of the equation, there was still an uncomfortable jump in inflation, with monthly services inflation still rising around 0.6%. There is a surprising persistence to inflation that can’t be written off and we’ve had to lift our year-end CPI forecast by 0.4% to 3.2% because of it.

The next couple of months present a lot of challenges to the UK. How will businesses react as the higher National Insurance Contribution (NIC) and Living Wage take effect, from April 2025? How will US tariffs effect goods prices? We, and many on the BoE, assumed that the 145% tariff on Chinese goods would flood the European market with cheaper Chinese goods that would bring down inflation. Now that’s down to 30%, this is less likely and is another reason why our inflation forecast has nudged higher.

Ultimately, the question rests on the tolerance of households to spend. Our case for continued cuts in the Bank Rate rest on a visible cooling labour market, notably in job vacancies. Yet, wage growth has been stickier in the UK and consumer credit growth is only ticking higher at just over 3% year-on-year – that’s alongside a fairly high savings rate of 12%. Even the BoE credit conditions survey hasn’t raised any alarm bells over potential defaults.

In other words, the UK consumer doesn’t look in bad shape overall as the rising living wages imply that inflation is squeezing a number of households, rather than breaking them. Households aren’t exactly driving prices higher and are generally pretty gloomy overall, but then again, they are absorbing the higher costs without breaking their stride. This means that the BoE will stay “data dependent” in the coming months and likely look for some softer wage data before they can argue that future one-offs in inflation can be looked through.

This means there is some risk to our call for an August Base Rate cut. Next month’s inflation will see some of those one-offs, such as air fares, push in the opposite direction, and given this month’s surprise it may be best to see how May’s inflation fares. In the meantime, it’s very notable that real gilt yields in the 5-10 year range rose by 10bps over the last day. This suggests that the BoE is set to be more hawkish, but the market doesn’t see this inflation surprise as a sign of more worryingly persistent inflation. This means that a medium to long-term investment in gilts is estimated to give an investor a post-inflation yield of over 2%. This looks like a good deal to us because further down the line we see reasons for inflation to fall – take the fact that it’s likely that employers will aim to claw back some of the NIC and Living Wage pressures through less wage growth over the next year or two. With this in mind, we stick to our gilt overweight.