In September, the inflation rate in the U.K. dropped sharply to 1.7%, below the Bank of England’s target of 2%. This unexpected decrease has ramped up market expectations for a rate cut by the Bank of England in November. Core inflation, which excludes certain items like energy and food, also decreased to 3.2% for the month. Prices in the services sector, which is a significant part of the U.K. economy, eased to 4.9%, the lowest rate since May 2022. These key indicators will be crucial for the Bank of England policymakers as they consider potential interest rate cuts at their November meeting.
Following the latest inflation data, there has been a significant increase in market pricing for a 25-basis-point rate cut by the Bank of England in November, with a further cut in December nearly fully priced in as well. Analysts believe that the lower wage growth reported by the Office for National Statistics supports the case for a rate cut. If two more quarter-percentage-point reductions occur this year, the BOE’s key rate will decrease to 4.5%. The British pound fell following these developments, with money market expectations becoming more dovish and yields on British government bonds dropping across the board.
Headline inflation in the U.K. has eased from a peak of 11.1% in October 2022 to September’s 1.7%. This shift suggests that the U.K. is transitioning into a more moderate inflation environment, aided by lower fuel prices. However, there are concerns that inflation might reverse its downward trend in October due to an increase in the regulator-set energy price cap. The Bank of England will likely wait to assess the impact of the U.K. Labour government’s upcoming budget at the end of the month before finalizing their course of action.
Some economists remain cautious about the situation, noting that a significant portion of the unexpected weakness in core and services inflation was due to a decrease in airfares prices. As a result, there is a likelihood that the Bank of England will stick to 25-basis-point cuts at alternate meetings, with a potential for two more reductions this year. Capital Economics’ Chief U.K. Economist Paul Dales believes that rates may eventually fall to 3.00%, lower than the market’s current expectations of 3.50-3.75%. On the other hand, Deutsche Bank’s Chief U.K. Economist Sanjay Raja sees the inflation figures as positive news that could lead to a faster unwinding of restrictive policies, including sequential rate cuts.
Overall, the sharp decrease in inflation in the U.K. has sparked expectations of a BoE rate cut in November. Market pricing suggests that there could be two more cuts this year, potentially taking the key rate to 4.5%. While some remain cautious due to potential factors that could reverse the decline in inflation, others see the current figures as an opportunity for more aggressive policy adjustments. The impact of the U.K. Labour government’s budget at the end of the month will also be critical in shaping the Bank of England’s decisions moving forward.
