The latest plunge in inflation to 4.6% will be cheered on Downing Street and Threadneedle Street alike, but economists warned today it will not be enough for the Bank of England to think about cutting interest rates.
The decline has been hailed as a key victory for Rishi Sunak, who pledged to halve inflation, but it’s also a win for the Bank of England. The Bank hiked interest rates 14 times in its effort to bring inflation back down to its 2% target, before back-to-back pauses at its last two meetings.
A sharp decline in the space of price rises was seen as almost certain as the new, lower, energy price cap came into effect at the start of October, reducing the amount spent on heating bills. But the rate fell even more quickly than City economists or the Bank itself predicted.
The rate-setting Monetary Policy Committee usually pays closer attention to core inflation - which strips out food and energy prices for a clearer picture of the long-term trends on prices. That rate fell more slowly to 5.7%, its lowest level since March 2022.
City traders already thought further rate rises were unlikely even before today. This morning, they upped their bets on rates having already peaked, seeing a rise as close to a one-in-fifteen chance now.
But they don’t see cuts any time soon. Markets suggest that the Bank is unlikely to cut rates until June. Dramatic falls in the headline inflation rate driven by changes to the energy price cap, as seen today, are much less likely in the year ahead, and the crisis in the Middle East threatens to send oil prices surging.
Thomas Pugh, economist at audit firm RSM UK, said: “The second half of the journey down inflation mountain will be tougher. Inflation probably won’t get back to something starting with a two before the second half of next year, and will require interest rates to remain in restrictive territory for a while yet, which is why we don’t expect interest rates to be cut until Q3 next year.”
Paul Dales, chief UK economist at Capital Economics, said: “We think the restrictions on labour supply and the stickiness of inflation expectations will mean that inflation fades slowly rather than suddenly.
“That explains why we think the Bank won’t feel comfortable cutting interest rates until late in 2024.”
The Bank has warned interest rates are likely to be ‘higher for longer’.Writing in the Standard last week, Governor Andrew Bailey said: “Rates will need to stay high for some time to make sure that inflation continues to fall.” If rates stay higher for longer, that will push more homeowners on fixed-rate mortgages with low interest rates onto higher-rate deals, sucking more demand out of the economy.
Jeremy Batstone-Carr, European strategist at Raymond James Investment Services, said that the Bank will still be reluctant to think about cuts until wage growth slows, as it is still concerned about the pace of pay rises. Official figures yesterday showed pay rising at 7.7%, close to record highs.
Batstone-Carr said: “Data earlier this week showed that average earnings are still far above levels deemed consistent with the 2% medium term target, and so despite today’s CPI fall the Bank will likely feel vindicated in continuing its guarded approach to interest rate policy.”
Yesterday, Bank of England Chief Economist Huw Pill said wage growth is still “stubbornly high”. He was widely criticised earlier in the year when he told the public not to ask for pay rises.
