Britain’s inflation rate unexpectedly dropped to its lowest level in 18 months, providing some relief and reducing the need for further interest rate increases from the Bank of England. The Consumer Prices Index (CPI) rose by 6.7% in August compared to the previous year, lower than the 6.8% increase in July, according to the Office for National Statistics. Economists had anticipated a rise to 7%. Additionally, core inflation, which excludes food and fuel, decreased from 6.9% to 6.2%.
The data is particularly significant for the UK, which has been grappling with the highest inflation problem among the Group of Seven countries. The lower inflation figures may make it more feasible for the Bank of England’s policy makers, led by Governor Andrew Bailey, to consider ending their most rapid monetary tightening cycle in 30 years when they make their decision on interest rates. It could also offer hope that Prime Minister Rishi Sunak will achieve his target of halving inflation this year.
Alpesh Paleja, the lead economist at the Confederation of British Industry (CBI), the UK’s largest business lobby group, stated, “Despite the latest fall, the Bank of England will still be concerned by signs of stubbornly high domestic price pressures.” He added that another interest rate increase is more likely than not, although future changes in monetary policy will be heavily dependent on data.
Following the news, the pound dropped by as much as 0.5% to $1.2334, its lowest level since May, as traders speculated that the Bank of England is approaching the end of its hiking cycle. The probability of a quarter-point increase in interest rates on Thursday also declined, with the market indicating a less than 60% chance of a hike, down from 90% earlier, according to swap pricing.
Geoff Yu, forex and macro strategist for EMEA at BNY Mellon, predicted that the Bank of England will follow the European Central Bank’s actions and increase the Bank Rate one final time on Thursday. He referred to this potential move as a “dovish hike,” which would be reinforced by the soft Consumer Prices Index (CPI) print for August.
The latest report defied expectations of a slight increase in prices due to a rise in fuel costs. It confirmed that the Bank of England’s efforts to curb inflation are gaining momentum. Melissa Davies, chief economist at Redburn Atlantic, explained, “With oil prices rising briskly in September, we can expect unhelpful monthly gains here that slow the deceleration in headline CPI.” However, she emphasized that inflation in the UK remains too high and will continue to ease until the end of the year.
The Bank of England’s main challenge now is to reduce inflation from the current 4% to its target of 2%. The easing of services inflation, which decreased from 7.4% to 6.8%, may alleviate upward pressure on wages, a concern for the Bank of England. Officials have been worried that rising wages and prices in service industries were embedding inflationary pressures in the economy.
Grant Fitzner, the chief economist at the Office for National Statistics, commented, “The rate of inflation eased slightly this month driven by falls in the often-erratic cost of overnight accommodation and air fares, as well as food prices rising by less than the same time last year.”
The Bank of England’s benchmark lending rate has swiftly risen to 5.25% from near zero at the end of 2021, which is starting to have a heavier impact on the economy. The worsening sentiment is the latest challenge for Chancellor of the Exchequer Rishi Sunak’s Conservative administration, which is trailing the Labour opposition in polls with little over a year until the most likely date for the next election. Sunak has made halving inflation one of his key priorities, while also striving to deliver growth to a population concerned about their squeezed living standards.
Chancellor Jeremy Hunt affirmed that the plan to address inflation is working, but acknowledged that it remains too high. He emphasized the importance of sticking to the plan to halve inflation to alleviate pressure on families and businesses, while also paving the way for sustainable economic growth.
Despite higher oil prices pushing producer input and output costs higher on a monthly basis, pipeline price pressures continued to ease. Compared to the previous year, the cost of fuel and raw materials declined by 2.3%, while the prices of goods leaving factory gates dropped by 0.4%.
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