UK Inflation Steady at 2.2% Leaves Door Open for Rate Cuts

UK inflation held at just above the Bank of England’s 2% target in August, cementing expectations that policymakers will cut interest rates again later this year.

(Bloomberg) — UK inflation held at just above the Bank of England’s 2% target in August, cementing expectations that policymakers will cut interest rates again later this year. 

Consumer prices rose 2.2% from a year earlier, the same pace as in July and below the BOE’s forecast, the Office for National Statistics said Wednesday. The reading was in line with the median expectation of economists surveyed by Bloomberg. Downward pressures from motor fuels, restaurants and hotels were offset by an upward push from air fares.

The figures are likely to keep the BOE on track for a further loosening in policy in coming months after it cut rates for the first time since the pandemic on Aug. 1, citing easing underlying inflation. They will also be welcomed by the new Labour government, which is banking on lower inflation and borrowing costs to help fuel the growth it says is needed to fix ailing public services and boost living standards.

Services inflation, a key gauge that has worried the BOE, rose to 5.6% in August from 5.2% in July. However, a pickup had been widely anticipated and is expected to prove temporary. Both services inflation and the headline rate are running below levels forecast by the BOE in August of 5.8% and 2.4%, respectively. 

While policymakers are expected to leave rates unchanged at 5% at their decision on Thursday, market expectations of further easing have been mounting. Traders are pricing in cuts for both November and December with five more to follow in 2025. The pound gained 0.1% to $1.3179.

“While the Bank’s Monetary Policy Committee will be reassured by today’s data, they’re likely to remain wary of loosening policy too quickly,” said Martin Sartorius, principal economist at the Confederation of British Industry. “Inflation is expected to pick up later this year and domestic price pressures, such as wage growth, still pose an upside risk to the outlook.”

The BOE decision this week will be announced a day after the Federal Reserve is expected to kick off its own easing cycle amid fears about the health of the US economy.

There are also concerns the UK economy is losing steam, with figures last week showing GDP flatlined for a second month in July after outpacing all of its Group of Seven peers in the first half.

Monetary policy remains restrictive and energy bills are set to rise from October, putting upward pressures on headline inflation. Meanwhile, Chancellor Rachel Reeves is expected to announce tax hikes in her Oct. 30 budget to fill what she claims is a hole in the public finances left by the previous government. 

The ONS said that the 22% monthly rise in air fares was the second-largest surge in the category since records began in 2001, driven by flights to European destinations. Prices for flights typically climb between July and August but fell last year, meaning it helped to push up the annual rate of headline inflation this year.

BOE Governor Andrew Bailey has advocated a cautious approach to reversing the most aggressive policy tightening in decades. However, he has also signaled growing confidence that the central bank is beginning to contain stubbornly high price pressures from the services sector and jobs market.

He said last month that second round inflation effects have been “smaller than we expected,” though he stressed that the “job is not completed.”

While traders see only a remote chance of a surprise cut tomorrow, the BOE may signal that it will resume loosening policy again in November. With the UK economy’s recovery fading, investors are starting to cement the view that the central bank will ditch its patient approach and move toward rate cuts at every meeting later this year.

There was further evidence that pipeline inflation pressures are receding. Factory gate prices that are paid by retailers rose by just 0.2% in August on last year – below forecasts for a 0.5% increase.

Input prices, paid by manufacturers, fell 1.2% on the back of a sharp decline in oil and fuel costs. Markets had expected a drop of 0.8%. Food input prices rose, partly as a result of a poor potato yield, the ONS said.

—With assistance from Mark Evans, Joel Rinneby, Harumi Ichikura, Alex Morales and Aline Oyamada.

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