Last week the Bank of England (BoE) cut interest rates from 4.5% to 4.25%, the fourth reduction since last summer when rates stood at 5.25%. The interest rate decision was not unanimous with five of the nine Monetary Policy Committee members voting to cut rates, two voting to keep rates on hold, and two voting for a larger cut to 4.0%.

The three-way split underlines the uncertainty about the inflation outlook in the light of US tariffs. Tariff-related disruption and price rises could put upward pressure on UK inflation. But such effects may be countered if the UK is flooded with goods redirected from the US due to high tariffs. It is also likely that uncertainty about US policy will weigh on growth.

The Bank expects the dampening rather than the inflationary effects to ultimately win out with weaker growth and lower inflation as a result of US tariffs. (The Bank’s analysis predates the UK-US trade agreement announcement. It, however, leaves average tariff rates on UK products higher than at the start of this year.)

While the Bank thinks inflationary pressures will moderate it expects headline inflation to rise over the coming months, from 2.6% in March to a forecast peak of 3.5% in the third quarter of this year.

That pickup largely reflects changes to the Ofgem energy price cap. The contribution of energy prices to inflation has been negative over the last 12 months, reflecting the large decline in the price cap last April, as energy prices fell after the spike in 2022–23. That decline has now fallen out of the year-on-year inflation calculation. With the regulator having increased the energy price cap by 6% last month energy prices will exert upward pressure on inflation in the coming months.

This is likely to be temporary. The Ofgem price cap, which is reviewed every three months, reflects wholesale energy prices in the months leading up to each change. Since the April cap was calculated, energy prices have fallen sharply. The oil price has dropped to a four-year low, down 20% since the start of April. In addition, Saudi Arabia, the world’s largest oil exporter, has increased production recently, reversing its previous strategy of holding back output to prop up prices. Natural gas prices have also fallen by about 20% since the start of April.

These effects will feed through to lower household energy prices towards the end of the year and beyond. The BoE forecasts that after reaching a peak of 3.5% in the third quarter of this year, UK inflation will fall back to just over 2.0% by the end of 2026.

Financial markets expect the Bank to ignore the summer blip in inflation and are pricing between two to three further 25bp rate cuts by the end of the year.

Energy prices have played an outsize role in the inflation of the last three years. Higher, more volatile energy prices have become the norm despite the growth of renewable energy, which rose from 2% of total UK supply in 1991 to 42% in 2023.

Over this period electricity costs for UK households have quadrupled. There are two key reasons why the growth of renewables hasn’t yet translated into lower electricity bills.

Firstly, electricity prices are influenced by the marginal cost of generation, which is often set by the most expensive fuel needed to meet demand – frequently gas. If demand surges, the grid may need to fire up a gas power plant. Even if a large chunk of demand has been met by renewable sources, the cost of that gas sets the price for all electricity sold at that moment, even the renewable portion.

Secondly, although the marginal cost of renewable energy production is close to zero, the additional system costs are significant. According to Professor Sir Dieter Helm, of Oxford University, “solar and wind are both intermittent technologies, and low-density and geographically widely distributed. The system costs of renewables are what matters. As more and more are added to the electricity system, they require not just a very large and costly rebuilding of the grid, but also more and more back-up generation for when the wind doesn’t blow and the sun doesn’t shine.”

Renewable energy holds out the prospect of abundant, low-cost energy. But getting there involves major and sustained investment, the cost of which falls on domestic and industrial consumers.