Unexpected Drop in Inflation Signals Potential Interest Rate Cuts

The UK has experienced an unexpected drop in inflation, with the annual rate falling to 1.7% in September, marking the lowest level in three and a half years. This decrease places inflation below the Bank of England’s target of 2%, potentially paving the way for upcoming interest rate cuts.

Official data revealed that lower airfares and petrol prices were the primary factors contributing to this surprising decline. The latest figures suggest that the cost of living, which surged in previous years—reaching a peak of 11% in 2022—may be stabilizing. The Bank of England had previously raised rates to combat soaring inflation, primarily driven by increased energy prices linked to geopolitical tensions, particularly Russia’s invasion of Ukraine.

Currently, UK interest rates stand at 5%. The Bank implemented its first rate cut in August but opted to maintain rates in September. However, financial analysts widely anticipate that a reduction will occur in November, following the latest inflation data. Susannah Streeter from Hargreaves Lansdown noted that the lower-than-expected inflation figures also raise the possibility of an additional cut in December.

Danni Hewson, head of financial analysis at AJ Bell, described a 0.25 percentage point cut as “pretty much nailed on” for November, with expectations for another cut in December significantly increasing. Yet, caution is warranted, as Yael Selfin, chief economist at KPMG UK, warned that inflation could rise again due to a projected 10% increase in household energy bills this month.

The Bank’s base interest rate significantly impacts the borrowing costs for consumers. Higher rates have resulted in increased expenses for loans and mortgages, which, in turn, can lead to elevated rents as landlords pass on costs. Conversely, savers have benefited from improved returns on deposits.

While the recent drop in inflation is encouraging, it does not necessarily mean that prices for goods and services are decreasing. Instead, it indicates that prices are rising at a slower rate. For instance, Maria, a community volunteer in Liverpool, emphasized the struggle many face as they prioritize essential expenses like food and heating. She mentioned that prices at major supermarkets have escalated, making it challenging to manage daily costs.

The decline in inflation—from 2.2% in August to 1.7% in September—was driven primarily by significant drops in airfares and fuel costs. Specifically, petrol and diesel prices fell by 10.4% compared to the same month last year, while airfare prices typically see a seasonal drop after the summer rush. However, it’s important to note that food prices, including staples like milk, cheese, and fruit, have increased, marking the first rise in food price inflation since March 2023.

Darren Jones, Chief Secretary to the Treasury, hailed the slowdown in price rises as “welcome news for millions of families.” He reiterated the government’s commitment to restoring economic stability and promoting growth, especially as they prepare for the upcoming Budget announcement.

This fall in inflation is particularly relevant as Chancellor Rachel Reeves prepares for her first Budget, set for October 30. Reeves is expected to propose significant tax rises and spending cuts amounting to £40 billion, a response to fiscal pressures and a need for budgetary balance. She has cautioned that “difficult decisions” regarding spending, welfare, and tax would be necessary.

Additionally, the inflation data from September is crucial for determining adjustments to various benefits, which typically rise in April. Notably, universal credit and other disability benefits are legally bound to increase by at least the inflation rate. However, the anticipated 1.7% rise for benefits will likely fall short of the 4.1% increase expected for the state pension, which is determined by the government’s triple lock policy.

In summary, the unexpected fall in UK inflation to 1.7% opens the door for potential interest rate cuts, which could provide relief to borrowers but may not alleviate the broader cost-of-living challenges that many households face.