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UK inflation dropped more than anticipated to a three-year low of 1.7 percent in September, causing traders to speculate on additional rate cuts from the Bank of England later this year.
Figures released on Wednesday by the Office for National Statistics reveal that inflation has fallen below the BoE’s 2 percent target for the first time since April 2021.
The yearly rise in consumer prices is lower than the 1.9 percent predicted in a Reuters survey of economists and is down from August’s 2.2 percent. This decline was driven by reduced airfares and petrol prices.
These numbers will be welcomed by Sir Keir Starmer’s government just ahead of a challenging Budget that includes substantial tax hikes. Chancellor Rachel Reeves aims to address a funding gap of £40 billion, according to sources close to the Budget process.
Investors are now betting on the BoE cutting interest rates for a second time during its November meeting following a quarter-point reduction in August, with an additional cut expected in December.
Previously, the likelihood of two quarter-point rate cuts by year-end was around 50 percent, as indicated by swap markets. This probability rose to 75 percent after the inflation data release. On Wednesday, the pound weakened by 0.6 percent against the dollar, trading at $1.30.
Paul Dales from Capital Economics stated that a rate cut in November was already expected before the latest data release. He added that the likelihood of another quarter-point cut at the December meeting has now increased.
JPMorgan Asset Management’s global market strategist, Aaron Hussein, noted that the inflation data and subdued wage growth indicate that the BoE is gradually managing inflationary pressures.
The yield on two-year UK government bonds, which are sensitive to rate changes, decreased by 0.09 percentage points to 4.04 percent.
Governor Andrew Bailey’s recent remarks suggested that the BoE could be more proactive in reducing borrowing costs if inflation continues to decline. Investors interpreted this as a signal that rate cuts are imminent in both the November and December meetings.
Core inflation stood at 3.2 percent, lower than the anticipated 3.4 percent, while services inflation dropped from 5.6 percent to 4.9 percent, primarily due to lower airfare price increases.
Services inflation is a crucial indicator of underlying price trends for the central bank. The 4.9 percent figure was significantly below the BoE’s forecast of 5.5 percent released in August.
This aligns with separate ONS data showing that UK wage growth declined to 4.9 percent in the three months to August, down from 5.1 percent in the previous quarter.
The decline in services inflation is significant for the central bank, according to James Smith, UK economist at ING. He believes that the BoE could accelerate rate cuts beyond November.
Even though headline inflation is expected to rebound towards 2.5 percent later this year as the impact of lower energy prices diminishes, Smith suggests that an expedited rate-cutting cycle is plausible.
The shape of Reeves’s Budget on October 30 and its impact on debt control will be crucial factors for the BoE’s December meeting.
Chief Secretary to the Treasury, Darren Jones, stated that Wednesday’s inflation figures will be well-received by millions of families, emphasizing that more measures are needed to support working individuals.
Despite benefiting many families, the sharp decline in inflation will adversely affect lower-income households, as the 1.7 percent figure from September will determine the uprating of working-age benefits next spring.