(Bloomberg) -- UK inflation slipped below the Bank of England’s 2% target for the first time in more than three years, spurring investors to bet on a quicker pace of interest-rate cuts in the coming months.
Consumer prices rose 1.7% in September compared to a year earlier, down from a pace of 2.2% 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 British central bank in August.
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The pound fell 0.6% to below $1.30 for the first time since August, and money markets bolstered wagers on interest-rate cuts. Traders are now betting on back-to-back rate cuts at the BOE’s November and December decisions, having previously favored only one reduction.
While the BOE’s Monetary Policy Committee has signaled a cautious approach since cutting rates for the first time in August, Governor Andrew Bailey acknowledged earlier this month that the bank could be “a bit more aggressive” if inflation continued to slow. Bailey’s planned appearances around global finance officials’ meetings in the US next week will be closely watched by investors for more signs of a dovish shift.
Thomas Pugh, economist at RSM UK, said the drop in inflation “effectively nails on a 25-basis-point rate cut” when the MPC next meets on Nov. 7. “This morning’s data is clear evidence that disinflation is continuing to move through the economy at pace, and should reassure the Bank of England that it can move to cut interest rates more aggressively,” Pugh said.
The easing in price pressures was driven in part by cheaper air fares and lower prices at the petrol pumps. Services inflation, which is being closely watched for signs of underlying price pressures, was 4.9% — the slowest pace since May 2022. That’s well below the BOE’s own forecast of 5.5%.
Regular pay growth cooled to the weakest pace in more than two years, separate data released on Tuesday showed. Another fall in vacancies also pointed to demand for labor continuing to moderate.
“All told, today’s inflation data should be music to the MPC’s ears,” said Sanjay Raja, chief UK economist at Deutsche Bank Research. “The case for sequential rate cuts is rising.”
There was still some reason for caution by policymakers, though. Inflation is expected to pick up again over the coming months, due to a smaller drag from energy bills. The BOE will also be scrutinizing Chancellor of the Exchequer Rachel Reeves’ first budget address on Oct. 30 for new spending that could add to inflationary pressures.
What Bloomberg Economics Says...
“September’s CPI report has made an interest rate cut from the Bank of England next month a near certainty. The drop in the headline rate below the central bank’s target will be fleeting but the slowdown in underlying inflation has raised the risk the BOE cuts again in December.”
—UK economists Dan Hanson and Ana Andrade. Read the full REACT on the Terminal.
The drop in inflation may prove double-edged for Prime Minister Keir Starmer as he tries to bolster public confidence in his Labour government after a rocky first few months. Wednesday’s number will be used to determine the annual increase in the £140 billion ($182 billion) working-age welfare bill, providing some relief to Reeves as she attempts to find £40 billion to shore up the nation’s finances.
But the unexpectedly low payments could also underscore Labour’s reluctance to expand welfare programs, after a controversial decision to cut fuel subsidies for pensioners. The Resolution Foundation calculated that a typical low-income family with two children in receipt of Universal Credit will now see their annual award rise by £253 in April, £74 less than if the increase were based on a 2.2% rise.
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%.
Factory gate prices fell 0.7% in the year to September, the steepest drop since October 2020 and below forecasts for a 0.6% decline in a further sign that price pressures are easing. Input prices, the cost of goods going into factories, shrank 2.3%.
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.
A 10% rise in energy cap that came in effect on Oct. 1 also won’t show up in the data until next month. Oil prices have grown more volatile amid expanding conflict in the Middle East and public sector pay settlements may contribute to stickiness in wage growth.
“There is still inflationary pressure out there,” 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, Mark Evans and Irina Anghel.
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