- The rate of CPI inflation has fallen to 4.6 per cent in the UK
- Analysts think that the BoE’s next move will be a rate cut – but when?
The headline rate of inflation fell sharply last month, dropping from 6.7 per cent in September to 4.6 per cent in October. By this point, any evidence of cooling inflation would be greeted as good news, but moving below the 5 per cent threshold provides a particular cause for celebration.
5 per cent is an important psychological value, below which price growth looks a lot more normal by historical standards, as the chart shows. At 5 per cent, prices take around 14 years to double – far better than the eight years it takes when inflation is at 9 per cent.
The government has met its inflation target
The government will be particularly relieved. At the start of the year, Prime Minister Rishi Sunak set himself the target of halving inflation by the end of 2023. As inflation stuck around 8 per cent (see chart) over the summer, it looked as though this would be a stretch.
To Sunak’s credit, the government has thrown its support behind the Bank of England (BoE) – in contrast to Liz Truss’s more adversarial approach – and (at the time of writing, ahead of the Autumn Statement) avoided explicitly inflationary tax and spending policies. In the King’s Speech earlier in the month, the PM announced that “my ministers will support the Bank of England to return inflation to target by taking responsible decisions on spending and borrowing”.
Yet it is debatable how much praise the government actually deserves. The latest big inflation drop was largely driven by a one-off swing in energy price inflation, driven by the impact of last year’s Ofgem price cap rolling off calculations. Following the inflation release, Nicholas Hyett, investment analyst at Wealth Club, noted that it was "dubious" for the government to celebrate a fall in global energy prices over which "it has no control”.
Wages are far higher than inflation
Softening inflation also means that wages are growing at a significantly faster rate than prices. ONS data released last Tuesday revealed that growth in regular pay was 7.7 per cent in the three months to September, slightly down on the previous period. Including bonuses, annual pay growth was significantly higher than inflation, at 7.9 per cent.
On the one hand, this should ease the cost of living squeeze. Yet Lisa Hooker, PwC lead for consumer markets, warns that rising rent and mortgage payments are impacting more people as the impact of higher rates feeds through to the property market. According to a recent PwC survey, almost a third of consumers report that they are planning to spend less on Christmas presents and festivities this year as a result.
High wage growth also makes wrestling inflation back to target more of a challenge. While 5 per cent is an important milestone, getting back down to the crucial 2 per cent inflation target could prove arduous. The BoE is concerned about the risk of energy price spikes arising from conflict in the Middle East, as well as the lingering impact of wage and price pressure. Rate-setters released more pessimistic forecasts in November, and now expect inflation to return to target by the end – instead of the beginning – of 2025.
The inflation-adjusted base rate is now positive
But crucially, interest rates are now higher than inflation for the first time since 2016. A year ago, the rate of inflation was running at 11.1 per cent and interest rates were 2.25 per cent – leaving inflation-adjusted interest rates at minus 8.85 per cent. Thanks to soaring inflation, monetary policy remained exceptionally loose in real terms – despite rising rates. Today, the inflation-adjusted interest rate is positive again, at 0.65 per cent. This reduces the case for further rate hikes, and economists think that further hikes are now unlikely.
Many analysts now expect rate cuts towards the middle of next year, although the BoE faces a tough balancing act: cutting too soon could reignite inflation, while waiting too long risks damaging employment and growth. The Institute of Chartered Accountants in England and Wales’s economics director, Suren Thiru, thinks there will be a three-way vote split as soon as the next Monetary Policy Committee meeting in December as at least one policymaker votes for a rate cut.
