UK Inflation Cools to 2.6%

The latest U.K. inflation print just gave the Bank of England one more reason to sharpen the scissors.

Annual CPI came in at 2.6% in March, cooling more than expected and surprising markets who had forecast a slight slowdown to 2.7%. While the core inflation figure, excluding food, energy, alcohol, and tobacco, remained sticky at 3.4%, the broader disinflation trend is now hard to ignore.

This softer-than-expected reading is already fueling speculation that the BOE could pivot more decisively in May, especially with global growth slowing and monetary easing becoming the new theme across major central banks.

Why the Miss Matters

Just a month ago, the Bank of England sounded cautious, forecasting a temporary jump in inflation to 3.7% by Q3. The February data seemed to confirm that outlook when inflation shot up to 2.8%. But today’s surprise dip has upended that trajectory, at least for now.

The biggest contributors to the deceleration? Recreation and culture prices, along with motor fuel costs. These were partially offset by a rise in clothing prices, but not enough to reverse the cooling trend.

Sterling rose modestly against the U.S. dollar following the data, climbing 0.25% to $1.3265, as traders re-evaluated the likely pace of monetary easing.

BOE Under Pressure

The BOE’s next policy meeting on May 8 is now shaping up to be a major event. Markets had already priced in the likelihood of a rate cut by mid-year, but this CPI print has brought those expectations forward. The central bank held rates at 4.5% in March, citing global uncertainties and a forecasted inflation rebound.

Now, with inflation surprising to the downside and growth still fragile, the case for cutting has become stronger.

There’s also an external catalyst: Trump’s tariff shock.

The U.S. president’s trade policy rollercoaster has rattled financial markets and hit global confidence hard. Although the U.K. avoided the worst of the tariff barrage (with a baseline 10% duty on exports to the U.S.), the broader impact on trade flows and business sentiment can’t be ignored.

Growth Still Fragile, But Improving

February’s GDP data offered a glimmer of hope. The U.K. economy expanded by 0.5% month-on-month, a better-than-expected performance given the broader slowdown across Europe. Still, with the BOE halving its 2025 growth forecast to just 0.75%, the path ahead looks shaky.

Any positive momentum could be easily derailed if trade tensions escalate or if the U.S. economy, still absorbing the tariff shock, slows more sharply than expected.

Inflation Expectations Shift

Back in February, the BOE warned that inflation would rebound due to rising energy costs and currency volatility. That’s still possible, particularly with oil prices trending higher and supply chains facing renewed disruption.

However, Capital Economics and other major forecasters now believe the balance of risks is shifting.

Ruth Gregory, deputy chief U.K. economist at Capital Economics, noted that while inflation might tick up in the coming months, the broader trend should remain downward. She predicts a return to the BOE’s 2% target by 2026, with downside risks mounting due to weak domestic demand and global deflationary forces.

Her key takeaway? “The tariff shock has tilted the balance of risks towards lower inflation and faster rate cuts.”

What Traders Should Watch

For traders, the key now is timing. The BOE could use the May meeting to signal a dovish turn, especially if April CPI and other economic indicators confirm today’s softer trend.

A full 25-basis-point cut may still hinge on how persistent the inflation dip proves to be. But even without a move, the language of the statement will matter. Any acknowledgment that inflation pressures are easing faster than expected will trigger re-pricing across sterling pairs and U.K. gilts.

Also worth watching: progress on a U.K.-U.S. trade deal. So far, the U.K. has managed to escape serious damage from Trump’s tariff regime, but further escalation could reverse that.

If the BOE sees deteriorating global demand alongside a strengthening pound, the case for easing could become irresistible.

Final Thoughts

Today’s inflation miss is more than just a data point, it’s a potential turning point. With core inflation still high but headline CPI surprising to the downside, the BOE has entered a window where proactive easing could do more good than harm.

Markets are already front-running the next move. Sterling’s reaction was modest, but expectations are shifting fast. With trade risks still hanging over the global economy and domestic growth far from robust, the BOE may not wait much longer.

Rate cut expectations are no longer just whispers. They’re knocking loudly at the BOE’s door.