Consumer price inflation slowed to 4.6 percent in the year to October, down from forecasts of 4.8 percent and down from 6.7 percent in September, the Office for National Statistics said on Wednesday.
Core inflation, excluding energy and food prices, and services inflation were closely watched by the Bank of England’s rate setters, and both also fell during the month.
The Bank of England has warned that base rates will remain high for some time to come
Softer inflation pressures have fueled expectations that the BoE will make as many as three interest rate cuts next year, following signs of a loosening labor market, slowing wage growth and weaker economic output.
Danni Hewson, head of financial analysis at AJ Bell, said: ‘The market’s expectation that we have reached the highest interest rates has been solidified today with just 3 per cent thinking the Bank of England will raise rates when it meets next month.
‘Forty percent expect interest rates to start falling in May next year, reaching a level of 4.25 percent by the end of the year, and that expectation is already starting to filter through to lenders.’
Thomas Pugh, economist at RSM UK, said: ‘This is unequivocally positive news for the broader economy and justifies the MPC’s decision to leave interest rates unchanged at 5.25 percent.
‘Indeed, inflation is now 0.3 percentage points below the forecast made by the MPC in August.
‘Inflation is likely to hover around current levels for the rest of the year before taking another step down in the first half of next year. However, the second half of the journey down the inflation mountain will be more difficult.”
Although forecasters expect a third straight break at the BoE’s December meeting, inflation still remains well above the BoE’s 2 percent target and is likely to rise well into the year.
Pugh warned that this will likely require rates to remain in ‘restrictive territory’ for some time to come, but predicts a first rate cut by the BoE in the third quarter of 2024.
Evidence of slowing British wage growth on Tuesday also added to expectations of looming interest rate cuts.
Wage growth before bonuses, a factor of particular importance to the BoE and its fight against inflation, was 7.7 percent in the three months to September, compared with 7.9 percent in the previous quarter.
The CPI falls to 4.6% in October, down from 6.7% and below forecasts of 4.8%
This figure is well above consumer price inflation, but contributes to a weaker economic outlook and a weakening labor market, proving that the BoE’s rate hike cycle is having the desired effect.
Rob Morgan, chief investment analyst at asset manager Charles Stanley, said: ‘Wage growth is one of the most important considerations for the BoE when it comes to setting interest rates.
“Continued wage growth will raise concerns at the BoE that the inflation fire will not be easily extinguished, and interest rates will have to stay higher for longer.”
Wage easing combined with a weakening labor market, with jobless claims up by around 18,000 this quarter, should convince the BoE that it simply needs to be patient to see wage growth and inflation return to more normal levels , rather than resuming rate hikes,” Pugh added.
Confidence is growing that the BoE rate hike cycle has already peaked and Governor Andrew Bailey has been at pains to reiterate that it is still too early to think about rate cuts.
Wage growth in the private sector is being closely monitored by the Bank of England’s interest rate setters
Three base rate cuts are expected before 2024
Despite this, the market is still pricing in as many as three base rate cuts for next year, the first of which will take place in May, according to data from Pantheon Macroeconomics.
Adding to the urgency of possible future cuts, Pantheon predicts that the UK economy will be weaker, inflation will fall faster and unemployment will be higher than the BoE expects in the coming year.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: ‘We have seen quite a big shift in market expectations for base rates in recent weeks.
‘This was absolutely not the message the MPC wanted to send in its monetary policy report… it indicated that inflation would be too high over the medium term.’
He added that if the bank were to keep interest rates at current levels throughout the year, “effective” interest rates and mortgage rates – the cost of borrowing when compound interest is taken into account – would rise, further hurting households and the broader economy come under pressure.
Change of direction: According to analysts at Pantheon Macroeconomics, markets now expect as many as three rate cuts next year
Pantheon predicts that the ‘effective’ mortgage interest rate will continue to rise if the base rate remains at 5.25%
James Smith, developed markets economist at ING, pointed to private sector pay, which remained unchanged in September.
“If you compare the most recent three-month period to the previous three months, the growth rate has slowed significantly,” he said.
‘That is a trend that we expect to continue. If you’re trying to build a model of wage growth, the most important factors right now are usually inflation expectations or labor market tightness…both of which are rapidly declining.
‘All this suggests that the Bank’s forecast of 6.6 percent private sector wage growth in March appears to be on target, and could even be negatively exceeded.
“We think these numbers could reach the 4 to 4.5 percent range next summer, and that could be one of the catalysts for rate cuts starting in August.”
It looks like the BoE will be wrong-footed again next year on the CPI
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