UK’s Unexpected Drop in Inflation Opens Prospect of Rates Pause

Britain’s inflation rate fell unexpectedly to the lowest level in 18 months, opening the prospect that the Bank of England could pause or even end its quickest series of interest rate hikes in three decades.

(Bloomberg) — Britain’s inflation rate fell unexpectedly to the lowest level in 18 months, opening the prospect that the Bank of England could pause or even end its quickest series of interest rate hikes in three decades.

The Consumer Prices Index rose 6.7% from a year ago in August, less than the 6.8% gain the month before, the Office for National Statistics said Wednesday. Economists had expected a rise to 7%. A core measure of prices stripping out food and fuel fell sharply to 6.2% from 6.9%.

Investors reined in bets for further tightening from the BOE after the release, driving the pound to the weakest level since May. Traders are fully pricing only one more increase this cycle to 5.5%. The odds of quarter-point hike on Thursday — which was almost guaranteed earlier this week — dropped to less than 60%.

The data is a relief for the UK, which for months has had the worst inflation problem in the Group of Seven. While the European Central Bank and US Federal Reserve have hinted their own tightening cycles could come to a close, the BOE so far has had to emphasize its determination to keep a lid on prices. It also may buoy hopes that Prime Minister Rishi Sunak will meet his goal of cutting inflation in half this year.

“The interest rate rises we have seen so far are doing their job and should be given more time to work before the Bank of England considers whether the base rate needs to rise further,” said Kitty Ussher, a former Treasury minister now working as chief economist at the Institute of Directors. 

What Bloomberg Economics Says …

“The big downside surprise in the UK’s August CPI release has raised the risk that the Bank of England doesn’t hike rates this week. On balance, we think the strength of pay growth will worry the central bank enough to deliver further tightening, but it could well come with a stronger signal that policymakers think this month’s move will be the last of the cycle. If that happens, and the drop in core inflation proves durable, it would all but quash the chances of a November rate rise, which is our current base case.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.

Sterling traded as much as 0.5% weaker to $1.2334. The yield on two-year gilts fell 15 basis points to 4.85%.

“We expect the Bank of England on Thursday to somewhat emulate the ECB and hike the Bank Rate one last time,” said Geoff Yu, forex and macro strategist for EMEA at BNY Mellon. “The move will likely be construed as a ‘dovish hike’ and this would be reinforced by the soft CPI print for August.”

This month’s report confounded expectations for a small uptick in prices due to an increase in fuel. It confirmed that the BOE’s effort to rein in inflation is gaining traction. 


While August’s lower-than-expected inflation reading will have cheered BOE policy makers, economists said it was too early to celebrate yet. 

“With oil prices rising briskly in September, we can expect unhelpful monthly gains here that slow the deceleration in headline CPI,” said Melissa Davies, chief economist at Redburn Atlantic. “Taking a step back, inflation remains far too high in the UK but will continue easing into the end of the year.”

The BOE’s real challenge, she added, would be getting inflation down from 4% to the 2% target.

Services inflation eased to 6.8% from 7.4%, which may relieve upward pressure on wages that has especially concerned the BOE. Officials were concerned that rising pay and prices across service industries were embedding inflationary pressures in the economy.

“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,” said ONS chief economist Grant Fitzner.

The swift surge in the BOE’s benchmark lending rate to 5.25% currently from near zero at the end of 2021 is starting to weigh more heavily on the economy. Official data and surveys show activity contracted in the first few weeks of the third quarter, reviving the risk of a recession.

The darkening mood is the latest headache for Sunak’s Conservative administration, which is trailing the Labour opposition in polls little more than a year before the most likely date for the next election. Sunak has made cutting inflation in half one of his five key priorities, but he’s also anxious to deliver growth to voters unsettled that their living standards are being squeezed.

“The plan to deal with inflation is working — plain and simple,” Chancellor of the Exchequer Jeremy Hunt said in a statement. “But it’s still too high, which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses. It is also the only path to sustainably higher growth.”

Pipeline price pressures continued to ease, despite higher oil prices pushing producer input and output prices higher on the month. Compared with a year earlier, the cost of fuel and raw materials fell 2.3%, while the price of goods leaving factory gates declined 0.4%.

“Despite the latest fall, the Bank of England will still be concerned by signs of stubbornly high domestic price pressures,” said Alpesh Paleja, lead economist at the CBI, Britain’s biggest business lobby group. “As a result, another rise in interest rates tomorrow still looks more likely than not, though changes to monetary policy beyond this will be very data dependent.”

–With assistance from Eamon Akil Farhat, Irina Anghel, Constantine Courcoulas, Alice Atkins and James Hirai.

(Updates with comment and market reaction.)

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