Inflation may have stuck at 2.8% in May but the fall-out from the Middle East war means the cost of living squeeze could still get worse as the year goes on
It’s been a rollercoaster year for households, with most desperately trying to work out what it all means for their finances.
There were signs of hope early on for millions still grappling with the cost of living crisis, with forecasts that pressure would ease as the year went on. And then came US President Donald Trump who, along with Israel, went to war with Iran in late February, sending wholesale energy prices soaring and forcing economists to rip-up their predictions. While the conflict sent shockwaves through the global economy, the feared surge in inflation here has yet to fully materialise.
The Consumer Price Index (CPI) measure of inflation actually fell from 3.3% to 2.8% in April, thanks largely to energy regulator Ofgem’s price cap dropping by an average £117 a year to £1,641. That followed measures announced by Chancellor Rachel Reeves to remove certain costs from bills.
And there is more good – albeit surprising – news that inflation remained at 2.8% in May, when most experts predicted a rise to around 3%.
Now the peace deal between the US and Iran – if it holds – has the potential to ease various household bills further. So what could the months ahead mean for your money, assuming, that is, there are no further political earthquakes?
What is inflation and where might it be heading?
Inflation is a measure of how the price of a whole host of goods and services are rising. It’s calculated using the Consumer Price Index and the change in its level over the year is the rate of inflation. For example, if CPI inflation is 2%, then a basket of goods that was £100 a year ago would be £102 today.
In fact, 2% is the Bank of England’s target and it uses different ways – the main one being interest rates – to try to keep it there. The problem is that it hasn’t been at 2% for some years. The Bank has previously said it thinks inflation will average 3.3% between July and September, then “rise somewhat further” between then and Christmas.
Research firm Pantheon Macroeconomics forecasts inflation will peak at 3.5% in November, then fall to 2.1% by July 2027. Others broadly agreed, with KPMG predicting inflation won’t go above 4%. That would still mean inflation remaining well above the Bank’s 2% target.
A 13% jump in Ofgem’s energy price cap from July 1 is expected to push up inflation and could dampen consumer spending. And the fall-out from the Iran war and the closure of the Strait of Hormuz will be felt for some time in the price of goods.
Alpesh Paleja, deputy chief economist at business lobby group the CBI, said: “This is likely to be the calm before the storm, with price pressures set to see a pronounced rise over the coming months.”
Among factors expected to keep a lid on inflation is cheaper ticket prices for families at various attractions such as theme parks, zoos and museums during the summer holidays. The Chancellor announced a temporary reduction in VAT from 20% to 5% from when schools break up in Scotland at the end of June until children return to classrooms in England, Wales and Northern Ireland on September 1. Under pressure PM Keir Starmer also confirmed an extension to a temporary 5p a litre fuel duty cut.
What will happen to energy bills?
Tens of millions of households are already going to pay the price of the Middle East war through their energy bills.
The surge in wholesale energy costs is the main reason Ofgem’s energy price cap will jump 13% to an average £1,862 a year from July 1. The cap is on the unit rate you’re charged, with the overall bill depending on your usage.
However, the cap is recalculated every three months and if – and it’s a big if – the Middle East ceasefire holds, then wholesale energy costs could fall. That should mean a lower price cap in October, and next January. The timing is crucial as, while any energy bill increase now is a bad, it is a much bigger blow come the winter when household heating use leaps.
What about food bills?
The cost of weekly shop – along with fuel – is where many families have seen the impact of soaring bills most acutely over recent years.
So it was worrying when the Institute of Grocery Distribution (IGD) warned in March that food price inflation could reach 8% by June. As it turns out, it actually fell from 3.7% to 3% in April, helped by Britain’s fiercely competition grocery market. It was even more surprising when the latest ONS data showed food inflation tumbled to 2.2% in May, with meat, dairy – especially cheese – vegetables, and fish falling in price from the previous month.
The signs are that the peak in food prices won’t be as bad as feared. The IGD now forecasts food inflation will hit a high of 5.5% in the second half of 2026.
However, the impact of higher wholesale energy prices, fertilizer, and other shipments will still take months to feed through. And any jump in the cost of weekly shop is on top of big incresases over recent years which have hit many families hard.
According to the IGD ‘s latest estimates, households with children will need to find around £203 extra for food and drink this year, as well as another £207 for next year. James Walton, chief economist at IGD,said: “While inflation may not peak as high as the most severe scenario, there is little room for relief as prolonged pressure will continue to weigh on both industry and household budgets.”
And fuel prices?
Many people’s direct experience of events in the Middle East was pain at the pump, with the cost of filling up soaring as a result of the oil price spike.
The average price of petrol soared 20% to 159.53p a litre at one stage, which was 27p more than it was on February 28. Diesel peaked at 191.54p on April 15, which was a 49p increase, or 19%, since the start of the war.
According to the ONS, petrol averaged 157,.4p a litre in May, up by 0.6p since April, and the highest since November 2022.
But after several months of sky high bills, petrol and diesel have begun to come back down. The RAC says that, if the ceasefire holds, petrol should fall to 148p a litre from its current average of 156p in the next couple of weeks. Diesel, which currently costs an average of 177p, ought to fall to under 160p, it says.
Wages
Most of what we’ve been talking about is outgoings, but what about what households have coming in?
Wage growth has slowed in the face of a tougher jobs market, and is one reason the Bank of England is expected to keep interest rates on hold on Thursday.
Pantheon Macroeconomics predicts figures this week will show private sector regular pay growth has dropped from 3% to 2.9%. If inflation picks up then it means the average worker will end up with a real terms wage cut.
Interest rates
The Bank of England was already highly likely to keep its base rate on hold at 3.75% when its Monetary Policy Committee meets to vote on Thursday. Now that looks “nailed on” according to Suren Thiru, chief economist at Institute of Chartered Accountants in England and Wales.
Lindsay James, investment strategist at wealth manager Quilter, said: “With the Middle East situation looking somewhat calmer, that can hopefully take rate rises off the table.”
Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK said: “Unexpectedly steady inflation in May eliminates any lingering chance of a rate hike tomorrow and will go a long way to taking a hike in July off the table as well. Lower oil prices eliminate the need to hike rates this year, but given input costs are likely to remain elevated we doubt the BoE will return to its rate cutting path until 2027.”
So while it doesn’t look likely the Bank’s base rate – which influences what lenders charge – will go up anytime soon, there’s also little prospect for now for them coming down. While that’s a blow for borrowers hoping for savings on their mortgage, some lenders have been lowering the cost of some new fixed rate home loans anyway.
Mike Ambery, retirement savings director at Standard Life, said: “For households and those planning for retirement, the squeeze may not ease quickly. Just because the (inflation) figure has not increased month on month, prices are still rising, and over time that can steadily reduce spending power, particularly for people approaching retirement.
“When essential costs rise, pension contributions can feel like an easy place to cut back, but doing so can mean missing out on tax relief, employer contributions and potential investment growth. Where affordable, keeping contributions going, or restarting them when possible, can help people stay on track.”
