UK inflation remains above target cementing interest rate pause

Having met the Bank of England’s target of 2% for two months in May and June, the Consumer Prices Index (CPI) measure of inflation reaccelerated to 2.2% in July and remained at that level in August. The data illustrates that inflationary pressure, while subdued, is not vanquished – by Rob Morgan

 
Tellingly, core inflation, which strips out volatile elements such as fuel and food, increased to 3.6% in August from 3.3% in July, higher than the Bank of England would like. This confirms underlying stubbornness in services inflation, which the Bank of England is closely monitoring.

The services figure jumped to 5.6% from 5.2% in July, and with utility bills no longer helping suppress the headline figure, the services element is having more of a bearing. What’s more, services inflation may be harder to eradicate from the system because of its lower sensitivity to energy prices and higher labour intensity – so its concerted subsidence is not a given.

Overall, the figures cast doubt on any expectations of a more aggressive path the BoE might take on cutting interest rates.
 

Will interest rates be cut further tomorrow?

 
Price rises rarely subside in a straight line, and the bigger picture remains intact: Inflation is heading in the right direction. Yet it is not doing so at a pace that would encourage the Bank of England (BoE) to act hurriedly.

Inflation previously returning to target over the summer offered a window of opportunity for the BoE to reduce interest rates, and a slim majority of MPC members opted for a cut on 1st August. However, with wage inflation remaining on the high side, feeding into services costs, and a reacceleration of energy prices it looks most unlikely the BoE will move to cut interest rates at its next meeting tomorrow.

Instead, a move lower in November is still very much on the cards. By this stage the data may well show a further moderation in inflation and wage pressures, plus any ramifications from the Budget on 30th October can be considered. It may be that a fiscally tight Budget further tips the scales towards a loosening of monetary policy. For now, the BoE will want to stay in ‘wait and see’ mode.

As the obstacles to further rate cuts are gradually whittled away, we will likely see BoE make a series of reductions at a steady pace, roughly quarterly, towards the 4% level by mid-2025. There could be a faster cutting cycle if growth disappoints, or inflation remains more firmly dampened down.
 

What does it mean for households?

 
The more subdued inflation pressure seen as 2024 has progressed is a great relief for households that have battled post-Covid cost of living challenges. With wage rises now outpacing inflation there’s an opportunity to rebuild reserves and get finances on a sounder footing.

Many households and businesses will now be hoping for further interest rate cuts, which will relieve some pressure on those with variable rate mortgages in particular. However, owing to the stickiness of inflation and wage growth the pace of cuts will be slow and steady. It will therefore be a case of continuing to battle against higher borrowing costs relative to much of the past decade.

While the worst of the burst of post-Covid inflation is behind us, several factors stand in the way of it staying low. These include the strong jobs market keeping wages buoyant, an overall benign picture for the UK economy, the more fractious geopolitical landscape, and the lingering effects of reconfigured post-Covid supply chains. People’s own expectations also play a role. According to our recent survey, 48% of private investors believe inflation will exceed the BoE target of 2% early next year.

Meanwhile, the interest rate picture remains positive for savers with the best fixed and variable rate deals still north of 4.5%, well ahead of the prevailing rate of inflation in the region of 2%. This ‘real’ rate of return is likely to narrow in the coming months as the Bank of England trims base rate further and inflation reaccelerates a little. It’s a case of making hay while the sun shines and not keep too much in cash as it gradually loses its appeal versus assets such as shares and bonds.
 
Rob Morgan is Chief Investment Analyst at Charles Stanley Direct