UK Inflation Dips to 1.7%, First Time Below Bank of England Target in Over 3 Years

The Office for National Statistics in the UK announced on Wednesday that the country's inflation rate in September plummeted to 1.7%, intensifying market expectations for a rate cut by the Bank of England in November.

Economists surveyed by Reuters had previously forecast that the overall inflation rate for September would rise to 1.9%, marking the first time since April 2021 that it fell below the Bank of England's 2% target.

Over the past four months, the UK's inflation rate has been hovering around this level, with an inflation rate of 2.2% in August.

Core inflation, which excludes energy, food, alcohol, and tobacco, stood at 3.2%, lower than the 3.6% in August and also below the 3.4% predicted by the Reuters survey.

As a major component of the UK economy, the price increase in the service sector slowed significantly from 5.6% in August to 4.9% last month, currently reaching the lowest level since May 2022.

Core inflation and service sector inflation are key points of observation for the Bank of England's policymakers, who are considering whether to cut rates again at the November meeting.

*Will the rate cut be successful?*

After the latest inflation data was released, the currency market's expectation for a 25 basis point rate cut in November soared from 80% to 92%, and a subsequent rate cut in December has almost been fully digested by the market. Analysts said on Tuesday that the slowdown in wage growth announced by the Office for National Statistics this week supports the rationale for a rate cut.Two more interest rate cuts this year would bring the Bank of England's base rate down to 4.5%. The Bank of England began cutting rates in August and continued to do so in September.

Following the release of Wednesday's data, the British pound fell, reflecting a more dovish outlook for the Bank of England. The pound dropped 0.6% against the US dollar to $1.299, falling below $1.30 for the first time since September 11. The pound also fell 0.5% against the euro.

Meanwhile, yields on UK government bonds, known as gilts, fell across the board. The yield on two-year UK government bonds fell by 9 basis points, while the yield on 10-year UK government bonds fell by 7 basis points.

The UK's overall inflation rate has dropped from a peak of 11.1% in October 2022 to 1.7% in September.

Suren Thiru, head of economics at the Institute of Chartered Accountants in England and Wales, said in a report: "The data are reassuring, with the UK having entered a more benign inflationary environment, helped by falling fuel prices." The "significant drop" in service sector inflation suggests that "underlying price pressures are becoming less problematic."

However, Thiru added that UK inflation could turn around in October due to an increase in the energy price cap set by regulators, and the Bank of England will wait until the end of the month to assess the much-anticipated first budget of the UK Labour government to see if there are potential inflationary impacts before determining its course.

Paul Dales, chief UK economist at Capital Economics, also expressed the same caution, noting that the unexpected weakness in core and service sector inflation was largely due to a significant drop in airfare price increases. Therefore, Dales said there is a slightly increased likelihood that the Bank of England will persist in cutting rates by 25 basis points at every other meeting, although the possibility of two more rate cuts this year has now risen.

He said: "We still believe that rates will ultimately fall to 3.00%, below the market-implied range of 3.50-3.75%."

However, Sanjay Raja, chief UK economist at Deutsche Bank, said that the inflation data would be a "pleasure" for the Monetary Policy Committee and could lead them to consider easing restrictive policies more quickly, including consecutive rate cuts.

Raja also pointed out the risks posed by the budget, stating, "Although there will be a large fiscal consolidation on October 30th, the budget could be expansionary."