UK Inflation Drops Below BOE Target, Boosting Case for Rate Cut

UK inflation slipped below the Bank of England’s 2% target for the first time in 3 1/2 years, a fall that sets the stage for a second interest-rate cut next month.

(Bloomberg) — UK inflation slipped below the Bank of England’s 2% target for the first time in 3 1/2 years, a fall that sets the stage for a second interest-rate cut next month. 

Consumer prices rose 1.7% in September compared to a year earlier, down from a 2.2% pace previously, the Office for National Statistics said on Wednesday. That’s lower than the 1.9% expected by economists and the 2.1% forecast by the BOE in August.

The pound fell 0.5% after the report to $1.3007, its lowest level in over a month, in a sign that investors are anticipating sharper rate cuts.

The drop in inflation was driven by cheaper air fares, lower prices at the petrol pumps and a step down in services inflation. Services inflation was 4.9%, below the median estimate of 5.2%. Food and non-alcoholic-drink prices provided a small offsetting push.

The figures may give rate-setters more confidence that price pressures are being contained, as they consider how quickly to reduce borrowing costs. However, inflation is expected to pick up again over the coming months, due to a smaller drag from energy bills.

Investors are awaiting further clarity from BOE Governor Andrew Bailey on how quickly the central bank will reverse its 14 back-to-back rate hikes. Officials are expected to cut rates again on Nov. 7 after reducing borrowing costs for the first time since the pandemic in August.

While the policymakers have signaled a cautious approach, Bailey has suggested that they could be “a bit more aggressive” with cuts if the good news on inflation continued. Bailey’s planned appearances in the US next week will be closely watched by investors for more signs of a dovish shift in tone.

Before Wednesday’s release, traders were fully pricing in just one more quarter-point cut by the end of the year, suggesting the UK will lag behind other top central banks in easing borrowing costs.

“Below-target inflation in September makes it increasingly likely that the MPC will choose to cut rates in November,” said Martin Sartorius, principal economist at the Confederation of British Industry. “These latest data will reassure members of the Monetary Policy Committee that price pressures are easing.”

Sterling has weakened around 3% from a two-year high touched in September, paring a peer-beating rally. The losses come amid a renewed bout of dollar strength and as investors reassessed the outlook for BOE policy. Investors responded to the latest inflation data by increasing bets on the BOE cutting at December’s meeting as well as next month, pricing in 41 basis points of easing by the end of the year.

UK rate-setters still have lingering concerns over the strength of domestic price pressures from the labor market and services sector. However, services inflation is running much lower than the 5.5% expected by the BOE at this point and is now at the lowest since May 2022.

Five of the main 12 categories tracked by the ONS saw inflation of less than 2%, compared with four last month. Food and drink, clothing, furniture, housing and transport prices grew by less than 2%. The biggest annual increases were in health and telecommunications.

Rate cut hopes were provided a boost on Tuesday by figures showing regular pay growth cooled to the weakest pace in more than two years. Another fall in vacancies also pointed to demand for labor continuing to moderate.

While overall inflation eased, food and non-alcoholic drink prices rose 1.9% on the year, up from 1.3% in August. It was the first time since March 2023 that price growth in the sector has strengthened.

“There is still inflationary pressure out there. Inflation is set to rise next month as the 10% rise in the Ofgem price cap comes into effect, oil prices are volatile, public sector pay settlements will contribute to stickiness in wage growth and the Bank will need to assess the inflationary impact of the Budget,” said Anna Leach, chief economist at the Institute of Directors.. “How these different factors play out will ultimately define the pace of interest rate cuts.”

—With assistance from Joel Rinneby and Mark Evans.