In September, inflation in the U.K. dropped sharply to 1.7%, below the Bank of England’s 2% target. Core inflation also decreased to 3.2%, while services inflation eased to 4.9%, the lowest rate since May 2022. These figures have increased market expectations for a Bank of England rate cut in November, with money market pricing indicating a high likelihood of a 25-basis-point cut in November and potentially another one in December. This would take the BOE’s key rate to 4.5%, following rate cuts that began in August.
The fall in inflation was largely attributed to lower price rises in the services sector, which is a key focus for Bank of England policymakers. The weakening British pound and a decline in government bond yields also reflected the dovish expectations for a rate cut. However, economists are cautious about the future trajectory of inflation. Suren Thiru noted that while current figures show a more moderate inflation environment, October could see a reversal due to an increase in energy prices. The BOE is expected to wait for the effects of the U.K. government’s budget announcement at the end of the month before making any further decisions.
Capital Economics’ Chief U.K. Economist Paul Dales highlighted that a significant portion of the unexpected weakness in core and services inflation was due to a decline in airfares. Despite this, he believes the BOE is likely to continue with 25-basis-point cuts at alternating meetings, leading to a gradual reduction in interest rates. However, Deutsche Bank’s Chief U.K. Economist Sanjay Raja viewed the inflation figures positively, suggesting that they could prompt the Monetary Policy Committee to consider a faster unwinding of restrictive policies, including sequential rate cuts. Raja also warned of the potential risk posed by the U.K. government’s budget, which is expected to be expansionary despite fiscal consolidation measures on October 30.
Overall, the decrease in inflation in the U.K. has raised expectations for a Bank of England rate cut in November, with market pricing indicating a high probability of such a move. While the lowered inflation figures have initially been viewed positively, economists are cautious about the future trajectory of inflation, especially with potential factors like energy prices and the U.K. government’s budget announcement looming. Despite differing views on the pace of rate cuts, it is clear that the BOE will need to carefully consider a variety of economic factors before making any decisions on interest rates in the coming months.
