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The Guardian - UK
The Guardian - UK
Business
Graeme Wearden

Investors cut bets on UK interest rate rise after surprise fall in inflation – as it happened

Inflation United Kingdom United States G7 The Bank of England Interest Rates Office for National Statistics US Federal Reserve
The Bank of England and the City of London
The Bank of England and the City of London Photograph: Dominika Zarzycka/SOPA Images/Shutterstock

Federal Reserve leaves rates on hold

A late PS: America’s central bank has voted to leave US interest rate on hold.

Federal Reserve policymakers have agreed unanimously to maintain US interest rates at the current level of 5.25% to 5.5%.

Announcing the decision, the Fed’s FOMC committee say:

Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy.

But, significantly, the Fed also still expects to raise interest rates by a quarter of one percent by the end of the year.

That’s according to the ‘dot plots’, where Fed policymakers estimate where they think rates will be in future.

Time to wrap up… here are today’s main stories:

Our Politics Live blog will be tracking Rishi Sunak’s u-turn on the UK’s net zero plans, with a speech due to start shortly…

We’ll be back tomorrow, with live coverage of the Bank of England’s knife-edge decision on UK interest rates, due at noon sharp.

Currently, the City money markets are indicating that ‘no change’ is a 53% chance, with a 47% possibility of another rate hike.

GW

Updated

Suddenly, the UK inflation picture looks a lot different than it did twenty-four hours ago, says Sanjay Raja, chief UK economist at Deutsche Bank.

We came into today’s data, expecting no major surprises. But today’s CPI report will certainly be seen as a very positive surprise for the MPC. In short, the August CPI print will give the MPC more optionality to pause in September. We now think tomorrow’s decision will be finely balanced. The big miss in inflation, alongside weaker growth momentum now stands in stark contrast to still sticky and elevated wage growth.

Putting it altogether, we now think the case for a pause is slightly stronger. But either outcome won’t surprise us tomorrow. More importantly, today’s data will likely raise the odds of a dovish pivot to the Bank’s forward guidance in September.

Another no-change prediction:

Inflation questions answered

Here’s a handy Q&A on today’s inflation figures, from PA Media:

Q: What is inflation?

Inflation is the term used to describe rising prices. The inflation rate refers to how quickly prices are going up.

Every month, the Office for National Statistics (ONS) works it out by checking the prices of a range of items in a “basket” of goods and services, including everyday things such as food and train tickets, or larger purchases like a car and a holiday.

If the price of something rises from £10 to £11 over a year, then that would represent annual inflation of 10%.

Q: What is behind last month’s surprise drop in inflation?

The latest dataset from the ONS showed the inflation rate slowed down last month. Analysts had expected it to rise from July’s figure.

Slowing food prices were one of the biggest reasons why the overall rate fell, with the largest falls coming from milk, cheese, eggs, vegetables and fish.

Hotel and accommodation, and air fare inflation also came down significantly last month, which helped to offset rises in other categories such as fuel prices.

Q: Does a fall in inflation mean things are getting cheaper?

Falling inflation does not mean things are getting cheaper, but that prices are rising less quickly than before.

Households are still facing a cost-of-living squeeze, with prices continuing to climb in supermarkets, and important costs such as petrol and diesel going up.

Other products such as alcohol, coffee and clothing also saw price increases accelerate last month.

Q: What does it mean for interest rates?

The latest figures are especially important because they could encourage the Bank of England to stop raising interest rates for a while.

Most economists thought that the Bank’s policymakers would lift rates to 5.5% on Thursday, from the current rate of 5.25%.

But after August’s inflation figure was released, financial market expectations of a rate hike dropped from about 80% to roughly 50%, meaning analysts think it could go either way.

The Bank watches monthly inflation figures closely because they give an indication of whether rate rises are working to slow the economy and bring inflation back down to its 2% target.

Q: What does it mean for mortgages?

If we are nearing the peak of interest rates then it gives some hope for mortgage holders who may be worried about fixing to a new deal.

But the Bank of England is unlikely to bring down interest rates for some time, meaning households will continue to endure more expensive borrowing.

The average five-year fixed residential mortgage was 6.09% on Wednesday, according to data from Moneyfacts.

Q: What is the outlook for inflation from here?

The Government in January pledged to halve inflation from 10.7% to around 5.3% by the end of the year.

Chancellor Jeremy Hunt claimed the latest fall in the CPI rate shows “the plan to deal with inflation is working – plain and simple”.

He added: “But it is 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.”

The Bank of England thinks that inflation will meet its 2% target by early 2025.

Updated

Sebastian Vismara, financial economist at BNY Mellon Investment Management, is in the camp forecasting the Bank of England will raise interest rates tomorrow.

Vismara explains that the welcome fall in underlying inflation could be ‘another false dawn’, so the BoE will want to see more signs that inflationary pressures are easing:

“The unexpected fall in UK headline CPI inflation from 6.8% in July to 6.7% in August (vs BoE and consensus at 7.1%) will be of great comfort for the Bank of England. Most importantly, core CPI inflation fell even more sharply from 6.9% to 6.2% (consensus 6.8%), and services inflation declined from 7.4% to 6.8% (vs BoE at 7.2%). The BoE sees the latter as key to judge the persistence of domestic price pressures.

We think the BoE will still hike interest rates by a further 25bps to 5.50% tomorrow. This could be the last hike given the recent loosening in the labour market and weakening in activity, but we think that risks for rates remain to the upside in the near term. UK wage growth data keeps surprising to the upside relative than the Bank’s forecasts, and core inflation remains high and has been very sticky, at least until recently. Energy prices have surged in the past few months and could increase further.

The global economy has been weakening since the last quarter, but not by enough to create much slack. In other words, there remains the risk that this easing in core inflation proves to be another false dawn, and that today’s fall stalls or even reverses in the coming months. The BoE is likely to want to see broader disinflation trends in play before ending its hiking cycle.”

Afternoon summary

Time for a quick recap.

Investors have been slashing bets on UK interest rates being increased again tomorrow, after a suprise fall in UK inflation.

Britain’s cost of living crisis eased a little last month, with August’s annual inflation rate dropping to 6.7% from 6.8% in July.

Economists had expected a rise, to around 7%, due to rising petrol prices. But instead, the headline rate of inflation fell – as did underlying (or ‘core’) inflation.

Chancellor Jeremy Hunt has hailed the drop as evidence that the government’s plan to halve inflation was on track.

And City investors have been reacting by cutting forecasts for UK interest rates.

Before today, another increase in borrowing costs at noon tomorrow looked to be nailed on. Now it’s more of a coin toss.

Right now, the markets indicate there is a 51% chance that the Bank of England leaves interest rates on hold, for the first time since November 2021, at their current level of 5.25%.

But that leaves a 49% chance that policymakers vote for another rise, taking Bank rate up to 5.5%.

Financial experts are split on what will happen.

Goldman Sachs predicts the BoE will hold rates unchanged, saying:

Combined with their recent dovish commentary, we now expect the MPC to keep Bank Rate unchanged tomorrow and lower our forecast for the terminal policy rate to 5.25% (from 5.5% before).

Sushil Wadhwani, a former Bank of England policymaker, told Radio 4’s Today programme:

I think it makes it less likely that the Bank of England will need to raise interest rates tomorrow.

Berenberg Bank says the decision, due at noon tomorrow, is on a knife-edge.

But another bank, BNP Paribas, predicts the BoE will plump for a ‘dovish’ hike’ – which means raising interest rates, but hinting that they’ve now reached their peak.

The pound fell to a four-month low when the inflation data was released, but has now recovered back to $1.24.

Shares in UK housebuilders have risen, helping to push up the FTSE 100 stock index by almost 1% today.

Updated

Edward Hutchings, Head of Rates at Aviva Investors, is also forecasting a rise in UK borrowing costs at noon tomorrow, saying:

“We expect the Bank of England to deliver a further 0.25% hike this week, their fifteenth hike in a row without a single pause. With this being delivered the day after the latest inflation data, it’s the narrative of the MPC Minutes released that are absolutely key in determining the current thinking of the Committee.

We expect they will be a little more balanced but also more forward-looking in their approach, thereby providing time to assess the lagged effects of the hikes delivered so far.

We believe this will likely be the last hike in this interest rate cycle unless the employment data strengthens significantly further from here.”

Updated

BNP Paribas predict 'dovish hike' tomorrow

Today’s UK inflation data now make tomorrow’s Bank of England meeting a close call between a pause and a hike, say analysts at BNP Paribas.

They told clients that the softness in today’s inflation data came as a shock “to us, the market and the BoE” (as we reported back at 6.30am, the markets expected a rise in inflation today).

BNP Paribas predict the Bank will vote to raise borrowing costs, though, saying:

  • Today’s soft UK CPI inflation data make tomorrow’s BoE decision a finely balanced one, but we maintain the MPC will err on the side of caution with a ‘dovish’ 25bp hike.

  • We think that the MPC will look past some of the weakness in services inflation, as it may be driven by volatility in summer pricing, and wait to be more certain of a more sustained softening in underlying inflationary pressures.

  • Risk management considerations would point to the BoE acting tomorrow rather than later.

Jürgen Maier, the former chief executive of Siemens UK, has criticised Rishi Sunak’s decision to (we believe) backtrack on the country’s net zero goals.

Maier says on X that:

I know from the many business people I speak to every week, that we are quietly getting on with our net zero plans. Sadly though, this Government is no longer with us.

You can track the latest here:

The debate at this month’s Bank of England policymakers meeting will be “particularly heated”, predicts Tomasz Wieladek, chief European economist at T. Rowe Price.

Wieladek says the Bank must juggle a mix of economic data. As well as today’s fall in inflation, the UK unemployment rate has started to rise, and the RICS housing market survey and the CBI retail survey have suggested the real economy is likely sliding into recession.

On the other hand, wage growth has been higher than the Bank expected.

Wieladek predicts this will mean we get one more increase in interest rates, tomorrow.

Although near-term inflation dynamics are looking better, and the weakness in demand demonstrates the monetary policy transmission mechanism is working, the medium-term inflation outlook likely worsened since August due to higher pay growth surprises.

Given this news, I expect the BoE to reach a compromise. It will hike by 25bps but also indicate this is probably the last rate rise in the cycle.

There are risks the BoE remains on hold.

Tomorrow’s UK interest rate decision looks like a coin toss after today’s surprisingly encouraging inflation report, says Craig Erlam, senior market analyst for UK & EMEA at OANDA.

What’s interesting is that markets now view tomorrow’s BoE interest rate decision as a coin toss between 25 basis points and hold.

Perhaps the MPC’s words from earlier this month in front of the Treasury Select Committee are still ringing in traders ears but given the entirety of the data, I think we’re more likely to see an ECB-style dovish hike tomorrow than a Fed-style stuttered exit.

During that Committee hearing, Bank of England governor Andrew Bailey predicted a ‘marked fall’ in inflation this year, and indicated that interest rates were near their peak.

Jack Barnett of The Times reports that Goldman Sachs is ‘a bit of an outlier’, by predicting the Bank of England will hold rates unchanged tomorrow (see earlier post):

Mike Riddell, head of Macro Unconstrained at Allianz Global Investors, predicts the Bank of England will raise interest rates tomorrow, but that it will be the last rise this cycle.

Riddell reckons the Bank will pause after this month’s meeting, to assess the economic damage caused by its steady increase in borrowing costs

He says:

  • We expect the Bank of England (BoE) to hike this month for the last time despite the surprise drop in inflation reported this week.

  • From our point of view, damage to the UK economy from all the global rate hikes this year is likely to be substantial, leading the BoE to pause after September to survey the damage.

  • We believe that this is the peak in global interest rates.

Dr Arun Singh, global chief economist at data analytics firm Dun & Bradstreet, warns that the increase in the oil price in recent months could push inflation higher soon:

“While it’s great to see that the Bank of England’s measures are continuing to lower inflation, this surprise drop in headline inflation implies businesses should remain cautious – particularly since global crude oil prices are rising rapidly, which could lead to higher fuel costs and another rise in inflation in coming months.

While it still seems likely that the BoE will raise rates, given the persistence and strength of service sector inflation and wage growth, this unexpected drop today has significantly raised the odds of the central bank pausing.

Should the BoE move to raise interest rates, we will be looking for signals that it is ready to hold rates for an extended period of time.

The other big story in business this morning is that prime minister Rishi Sunk is, reportedly, planning to row back on some of the government’s net zero policies.

The PM is expected to drop measures that impose a direct cost on consumers, which could include delaying a planned ban on sales of new petrol and diesel cars from 2030 until 2035.

Car industry leaders have already slammed the move, which leaked last night, as “incredibly confusing” and “hugely retrograde”.

Sunak has now holding an emergency cabinet meeting to discuss the situation with ministers, and the word from Westminster is that he’ll give a press conference at 4.30pm today to outline the u-turn.

Sunak’s own MPs seem split about the plan too, with rightwingers sceptical about climate measures delighted, and green Tories alarmed.

Our Politics Liveblog has all the action:

Confirmation that the City now believes the Bank of England is more likely to leave interest rates on hold tomorrow, than to raise them again:

Updated

Kim Crawford, global rates portfolio manager at JP Morgan Asset Management, argues that it’s too early for the Bank of England to pause its interest rate increases.

Crawford cautions that the BoE shouldn’t declare victory in the fight against inflation too soon, by leaving rate on hold tomorrow.

‘The Bank of England’s decision is more finely balanced as activity data weakens more clearly, but a pause at this meeting could backfire.

‘Since the last meeting, services inflation has come in lower than the Bank of England’s forecasts, and there has been clearer demand-led loosening in the labour market, but wage growth has still continued to surprise to the upside.

‘It is too early for the Bank of England to be sufficiently confident that the current level of interest rates – even if held for a longer time – will be enough to return inflation to target, when it is staring down the barrel of 8% private sector wage growth.

‘The Bank of England has to prioritize its inflation credibility, and a pause here could be declaring victory too soon

Updated

British government bonds, or gilts, have had a strong morning after this morning’s inflation report fuelled expectations that the Bank of England could leave interest rates on hold tomorrow.

Two-year UK bond prices, which are sensitive to interest rate expectations, have jumped. That has pushed down the yield on these two-year gilts by 13 basis points, to 4.86% from 4.99% last night.

For context, they had been as high as 5.5% in July, before we saw signs that UK inflation was starting to meaningfully fall this summer.

Here’s Bloomberg on how this morning’s inflation report has shaken up the City:

Traders slashed the odds of a Bank of England interest-rate increase this week after data showed inflation unexpectedly slowed in the UK.

Swap-market pricing now implies less than a 50% chance for a quarter-point hike by the BOE on Thursday, a significant shift from an increase being seen as all but guaranteed earlier this week. That also contrasts with economists’ expectations for another hike to 5.5%.

Goldman: Bank of England will hold interest rates tomorrow

Goldman Sachs, the Wall Street bank, have cut their forecast for UK interest rate rises for the second time this week.

Goldman now predicts that the Bank of England will leave interest rates on hold at 5.25% at noon on Thursday, having previously expected a rise.

Following the drop in UK inflation this morning, they say:

Combined with their recent dovish commentary, we now expect the MPC to keep Bank Rate unchanged tomorrow and lower our forecast for the terminal policy rate to 5.25% (from 5.5% before).

On Monday, Goldman dropped their forecast that the Bank would raise interest rates at its November meeting, but make one more rate rise tomorrow.

Updated

The money markets are now indicating the Bank of England is more likely to leave interest rates on hold tomorrow than to raise them.

The latest predictions, based on the price of interest rate swaps traded between investors, are that ‘no change’ is a 55% chance, while an increase in borrowing costs (to 5.5%) is a 45% prospect.

Updated

The details of today’s inflation report show that food inflation pressures eased, but items were still much pricier than a year ago.

On an annual basis, prices of food and non-alcoholic beverages rose by 13.6% in August, down from 14.8% in July.

Within that, there were dramatic differences – sugar is 55% more expensive than a year ago, while low-fat milk cost 4.4% more.

Restaurants and hotels price inflation also cooled, with prices up by 8.3% per year in August, down from 9.6% (with prices down 0.2% in August alone).

Inflation for furniture and household goods dropped to 5.1%, down from 6.2%.

While miscellaneous goods and services price inflation eased to 5.6%, from 6%.

Updated

Charles Hepworth, investment director at GAM Investments, predicts that the Bank of England will probably raise interest rates by a quarter of one percent tomorrow, from 5.25% to 5.5%, and that this will be the peak.

Hepworth predicts a ‘dovish final hike’ at noon tomorrow:

“UK inflation came in less than forecast in August, rising 6.7% year on year against market expectations of a 7.0% rate. Core inflation which excludes energy and food inflation fell to 6.2% - a much larger drop from the previous months rate of 6.9%.

This welcome drop in inflation against forecasts will be perceived positively by the government that its plan is working and may even lead to some division at the Bank of England’s meeting tomorrow. However, we should probably still prepare ourselves for a dovish final hike in rates in this cycle.”

Updated

Just in: UK rents have continued to climb, as tenants suffer badly from the cost of living squeeze.

The Office for National Statistics reports that private rental prices paid by tenants in the UK rose by 5.5% in the 12 months to August 2023, up from 5.3% in the 12 months to July 2023.

That’s the highest rate since the ONS started tracking this data, in 2016.

On Monday, estate and letting agent Hamptons reported that the average rent on a newly-let property jumped by 12.0% year-on-year in August, the fastest growth since its index started in 2014.

The ONS data covers all tenants, not just those signing new contracts.

Berenberg: Final BoE rate hike on a knife edge

The question of whether the Bank of England raises interest rates tomorrow for a 15th, and likely final, time in a row is “on a knife edge”, says Kallum Pickering, senior economist at Berenberg Bank.

Pickering writes this morning:

By and large, the downside surprise to August inflation is the result of weakening domestic price pressures exceeding the inflationary effect of the rising oil price.

This will be welcome news for policymakers at the Bank of England (BoE) as they deliberate this week whether or not to further raise the bank rate from 5.25% in order to add even more downward pressure to domestic demand and thus prices. The BoE decision will be announced at 12:00 (BST) tomorrow.

The market for overnight index swaps (OIS), which had dramatically cut its bets for the peak bank rate in recent weeks (from a high of 6.5% in early July - which we had pushed back against), has now lowered its bet on a further final 25bp hike to a c50% chance from a virtually certainty yesterday.

A table showing UK headline inflation – outturn vs BoE projections

The right-wing thinktank, the Institute of Economic Affairs, finds itself in rare agreement with the TUC this morning,

Like the trade union movement (see earlier post), Julian Jessop, economics fellow at the IEA, argues that the Bank should leave interest rates on hold tomorrow:

“Today’s better than expected UK inflation data show why forecasters and policymakers should pay more attention to monetary aggregates.

Inflation was widely expected to jump due to higher fuel prices. In fact, it fell, which is consistent with the sharp deceleration in the growth of the money supply over the last year.

“The Bank of England should have hit the pause button on interest rates several meetings ago to assess the full impact of the tight squeeze that is already in place. Even if the MPC does decide to hike one more time this week, they should signal that rates are then on hold for a long period – and that the next move is just as likely to be a cut.”

JRF: Inflation damage means costs of essentials are literally unaffordable

Although inflation is now falling, it remains high – and “the real damage has largely been done”, points out Alfie Stirling, chief economist at the Joseph Rowntree Foundation.

Sterling says:

For 7.3 million low-income households, the costs of essential goods and services have reached a level that is literally unaffordable. For those already skipping meals and going without hot water, the rate at which prices continue to rise is now secondary.

He adds that people are “increasingly being squeezed from all sides”:

Not only is the price of money itself rising rapidly – in the form of interest on credit cards, loans and overdrafts – but this is slowing wider spending in the economy too, increasing the risk of lost work and earnings.

“Government can and should be doing much more to protect living standards for those on the lowest incomes. This starts with following the existing rules and raising benefits at least in line with inflation. And poverty charities, national health organisations and the wider public now all agree that the next step is a new guarantee that as a minimum benefits must always cover the cost of essentials.”

Updated

This morning’s fall in inflation will fill the nation’s mortgage holders with hope that “the tide has well and truly turned”, says Ben Thompson, deputy CEO at Mortgage Advice Bureau.

Significant month-on-month falls ramp up the likelihood that the Bank of England will hold off on increasing rates right now. This will likely be a breath of fresh air for those on variable rates or trackers, especially if this means that interest rates are near, or at, their peak.

“There is better news for those looking to remortgage and, indeed, prospective buyers. This is due to the steady decline of swap rates, meaning many lenders have reduced rates on various deals. Although swap rates remain high in comparison to the past decade, they are some of the lowest rates we’ve seen in the past year.

Simon French, chief economist at City investment bank Panmure Gordon, argues that of the Bank of England raises interest rate tomorrow it “would have the hallmarks of a policy mistake”.

He told clients this morning:

The latest UK inflation data continues a trend of softer price setting behaviour in the UK economy since the start of Q3 [the July-September quarter].

With a range of other relevant indicators also telling the Bank of England to pause for breath, we think anything else at the September MPC meeting would have the hallmarks of a policy mistake.

The UK is not out of the woods on inflation – with murmurings in oil and soft commodity markets demanding vigilance – but the recoupling with global price trends that we have expected all year is now well underway.

Shares in UK housebuilders are rallying this morning, as City traders anticipate that UK mortgage rates may drop sooner and faster than previously thought.

Taylor Wimpey (+5.2%) and Barratt Development (+4.5%) are leading the risers on the FTSE 100 index of blue-chip shares this morning.

Housebuilders have warned that the increase in mortgage rates this year has cooled demand for new homes.

This has helped to lift the FTSE 100 by 0.5%.

The smaller FTSE 250 index of medium-sized companies, which is more closely linked to the health of the UK economy, has jumped over 1%.

Victoria Scholar, head of investment at interactive investor, explains,

“The FTSE 100 and the FTSE 250 which is more closely correlated to the UK economy, are staging gains while the pound is under pressure after UK inflation fell in August, despite forecasts for a slight uptick.

UK housebuilders like Taylor Wimpey, Barratt Development, Land Securities and Berkeley Group are trading near the top of the FTSE 100 thanks to the better-than-expected inflation print.

Updated

Small firms call for end to interest rate rises as inflation stalls

Small businesses are also hoping that the Bank of England’s policymakers could resist raising interest rates for the 15th time in a row tomorrow.

Martin McTague, national chairman of the Federation of Small Businesses (FSB) says:

“It’s fair to say small firms will be relieved there wasn’t a rise in inflation, as some had predicted, but this result is far from the substantial fall they were hoping for.

“With signs that interest rate rises are starting to bite, tomorrow’s base rate decision by the Bank of England has to be the peak for rates, one way or another.

“Leaving rates high for longer than needed will devastate the chances of an economic recovery.

“Small firms are living with the effects of inflation that has been far higher than the target for many months now, so today’s inflation results aren’t enough alone to remove their worries about the economic situation, especially given the fall in GDP (gross domestic product) announced last week.”

McTague adds that around one in ten small businesses say they are at least at moderate risk of insolvency, so the government should produce measures to support them in the upcoming autumn statement.

That should including overhauling business rates, and extending the current discount for retail, hospitality and leisure businesses beyond next April, the FSB says.

The TUC are urging the Bank of England to leave interest rates alone this month, rather than inflict another rise in borrowing costs.

TUC General Secretary Paul Nowak says another increase in Bank rate tomorrow would harm the economy, saying:

“A halt to interest rate rises is long overdue.

“Pushing interest rates so high that the economy is driven into recession will only make the current crisis worse, costing people their jobs and their homes.”

Debapratim De, senior economist at Deloitte, the Bank of England has ‘additional room’ to not increase interest rates tomorrow.

De explains:

“The surprise fall in inflation in August keeps price rises on a reassuring downward trajectory. The easing in core and services inflation is another positive development, but underlying price pressures remain elevated.

There is a long road ahead to getting inflation back to its pre-pandemic normal.

“Although many expect the Bank of England to raise interest rates by 25 basis points this week, today’s figures will give it some additional room for manoeuvre, should it choose to pause tightening instead.”

Odds of interest rate rise falls after inflation drops

The financial markets have slashed their chances of another increase in UK interest rate at noon on Thursday, following the drop in UK inflation to 6.7% in August.

1pm UPDATE: The money markets indicate that a quarter-point rise in UK interest rates tomorrow (from their current level of 5.25%, to 5.5%) is now less than a 50% chance, down from around 80% yesterday afternoon.

The odds of no-change have risen from around 20% to 45% around 55% at 1pm today.

As this post shows, the market-implied peak of UK interest rates has dropped, with investors no longer certain that rates will hit 5.5%.

The yield, or interest rate, on UK government bonds is also falling this morning, as investors cut their forecasts for how high UK interest rates will rise.

That could be a boost to people looking to remortgage in the coming months, as the yield on two-year UK bonds is used to price those home loans.

Updated

Why the Bank might still raise rates tomorrow

Nick Rees, foreign exchange market analyst at Monex Europe, argues that the Bank of England will not be dissuaded from hiking interest rates again tomorrow, despite today’s drop in inflation.

Rees says the shock deceleration in UK inflation is good news for the BoE, but suspects its policymakers will want to be sure this is not just a one off fluke.

Also, they want to see a sustained slowdown in wage growth before calling an end to policy tightening.

Rees says:

Whilst we believe today’s latest round of inflation data likely comes too late to change many minds on Threadneedle Street, the slowdown in price growth is likely to set tongues wagging over the prospects of a hold in rates tomorrow.

Indeed, headline CPI growth dropped to 6.7% YoY in August, down from 6.8% last month, despite consensus expectations having looked for an increase in the measure in this latest release.

More crucially, underlying inflationary pressures softened even faster, putting the end of policy tightening in the UK front and centre for markets.

Given the still elevated pace of wage growth and the fact that underlying inflation pressures have only just started to break lower, we expect that the BoE will still choose to raise rates tomorrow lunchtime, though risks to this view are now clearly skewed to the downside.

But if the Bank does raise rates again, from 5.25% to 5.5%, that could well be the last increase in the current cycle, Rees adds.

Wadhwani: Bank of England less likely to raise rates tomorrow

Sushil Wadhwani, a prominent economist and former Bank of England policymaker, has predicted that UK interest rates are less likely to rise tomorrow.

Speaking on Radio 4’s Today programme, Wadhwani points out that the components which caused today’s downward surprise in inflation, such as hotel prices, are volatile.

But even so, today’s inflation data is “good news”, Wadhwani says:

I think it makes it less likely that the Bank of England will need to raise interest rates tomorrow.

The Bank last time told us that there were three things that they were looking at. They were looking at whether the labour market was loosening. They were looking at what would happen to services inflation, and they would look at wages.

Now two out of those three things have gone favourably in the sense that the labour market has loosened more than they thought, services today came in below their forecast [it slowed from 7.4% to 6.8%.]

However, wages are still growing “rather faster” than the Bank expected (total earnings in the three months to July 2023 were 8.5% higher than in the same period a year earlier – the highest since modern records began in 2001).

But even so, Wadhwani says he would be “thinking very seriously” about pausing interest rate rises tomorrow, if he were still a member of the Bank’s Monetary Policy Committee.

Resolution: Surprise fall provides ‘inflation karma’ for the Bank of England

Today’s surprise fall in the UK’s inflation rate to 6.7% in August will strengthen the case that interest rates are at or near peak, says the Resolution Foundation.

They point out that today’s latest inflation data is well below the Bank’s forecast that inflation would rise to 7.1% in August.

That is “payback” for the BoE, after several months of disappointing data coming in higher than expected.

While inflation is still uncomfortably high in Britain – and higher than any other G7 economy – the latest data suggests that it is heading in the right direction at least, Resolution say.

James Smith, research director at the Resolution Foundation, explains:

“After months of disappointing data, the Bank of England has finally received some ‘inflation karma’ as price pressures eased considerably in August.

“This will strengthen the case that the Bank’s fourteen consecutive interest rate rises are now showing clear signs of putting downward pressure on inflation, and that its rate-rising cycle will soon end.

“But while mortgagors will welcome the end of interest rate rises, Britain’s wider cost-of-living crunch is likely to continue well into the coming election year.

Despite August’s drop in inflation, prices are still rising faster in the UK than in many other major economies.

Here’s the latest inflation figures, for last month:

International inflation rates
International inflation rates Photograph: ONS

Hunt: Our plan is working.

Jeremy Hunt has hailed this morning’s drop in inflation as a sign that the government’s economic strategy is delivering results.

The chancellor says:

“Today’s news shows the plan to deal with inflation is working – plain and simple.

“But it is 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.”

That plan has included a reluctance to accept inflation-beating public sector pay rises, prompting today’s joint strike by consultants and junior doctors.

But shadow chancellor Rachel Reeves points out that the UK is forecast to have the highest inflation of any major economy this year (see earlier post), adding:

“The Prime Minister is too weak to turn things around, while his predecessor Liz Truss continues to call for the same policies that crashed the economy this time last year.

“The Conservatives have wreaked havoc and working people are paying the price.”

Updated

Here’s Grant Fitzner, chief economist at the Office for National Statistics, on August’s surprise drop in UK inflation:

“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.

“This was partially offset by an increase in the price of petrol and diesel compared with a steep decline at this time last year, following record prices seen in July 2022.

“Core inflation has slowed this month by more than the headline rate, driven by lower services prices.”

Pound falls to lowest in four months

The pound has dropped to its lowest level in almost four months, following August’s welcome drop in inflation.

Sterling has shed half a cent against the US dollar to hit $1.2335, the lowest since late May.

Traders are calculating that the surprise drop in the CPI rate eases some of the pressure on the Bank of England to keep raising interest rates.

Thursday’s BoE meeting might bring the final increase in borrowing costs in the current rate-hike cycle.

The pound vs the US dollar, September 20th 2023
The pound vs the US dollar today Photograph: Refinitiv

Ipek Ozkardeskaya, senior analyst at Swissquote Bank, says:

British inflation unexpectedly eased from 6.8% to 6.7% in August, and core inflation fell from 6.9% to 6.2%.

The surprise fall in UK inflation triggered a kneejerk selloff in sterling, as today’s data cements the expectation that the Bank of England’s (BoE) next rate hike could also be its last.

Motor fuel prices rose last month, the ONS reports.

The average price of petrol rose by 5.3p per litre between July and August, to 148.5p per litre, today’s inflation report shows.

Similarly, diesel prices rose by 5.9p per litre this year to stand at 151.1p per litre.

These movements resulted in motor fuel prices falling by 16.4% in the year to August 2023, compared with a larger fall of 24.9% in the year to July.

UK core inflation drops to 6.2%

In another boost to the UK economy, core inflation has fallen.

The rate of core CPI, which strips out energy, food, alcohol and tobacco, rose by 6.2% in the 12 months to August 2023. That’s a sharp fall on July, when core CPI was 6.9%.

Core inflation is an important measure for central bankers, as they try to assess how high to raise interest rates to squeeze out inflationary pressures.

At 6.7%, UK inflation is now its lowest level since February 2022 – the month when Russia’s full-scale invasion of Ukraine began to drive up the cost of oil and food.

On a monthly basis, UK inflation rose by 0.3% in August alone.

The largest downward contributions to the monthly change came from food, the Office for National Statistics reports, as “prices rose by less in August 2023 than a year ago”.

Accommodation services, where prices can be volatile, also fell in August 2023, the ONS adds.

UK INFLATION FALLS

Newsflash: UK inflation has unexpectedly fallen in August, as the cost of living pressures on households continued to ease.

The Consumer Prices Index, which tracks annual price changes, has fallen to 6.7% in August, down from July’s 6.8%.

That’s lower than the expectations of City economists, who forecast a rise to 7%, and comes despite the chancellor’s fears of a ‘blip’ higher.

This could ease some of the pressure on the Bank of England to raise interest rates again, tomorrow.

But, this still leaves inflation over three times above the UK’s target of 2%.

More to follow…

Updated

The broader picture is that the UK economy is expected to see the highest inflation rate of any G7 advanced economy this year.

Yesterday, the Organisation for Economic Co-operation and Development (OECD) forecast that UK inflation to be 7.2% in 2023, which would be the fastest rate across the G7 and the third fastest across the G20.

Analysts at RBC Capital Markets point out that the Bank of England is already braced for an increase in CPI inflation in August.

They told clients that the Bank’s latest predictions showed a rise in inflation for August:

The August Monetary Policy Report showed inflation rising to 7.1% y/y last month (mainly a function of fuel prices).

The risk to the Bank’s projections is likely to come from services inflation. The August MPR saw a slight decrease in services inflation to 7.2% y/y but given the slight miss in the July outturn vs. forecast we think that the risk is that services inflation will surprise to the upside again this month albeit marginally.

The Committee will have had pre-release access to the data on Monday ahead of their meeting [this week].

Introduction: UK inflation in focus

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

The UK’s battle against the rising cost of living may suffer a reversal today, when the latest inflation data is released.

The UK Consumer Prices Index for August, due at 7am BST, is expected to rise for the first time in six months.

Prices are forecast to have risen by 7% in the year to August, up from July’s 6.8%.

As this chart from last month shows, CPI inflation had been dropping back from its peak over 11% last autumn.

These declines had bolstered the chances that the government hit its target of halving inflation this year.

But earlier this month, chancellor Jeremy Hunt warned we could see a “blip” higher in inflation this month, as average fuel prices have jumped back above £1.50 a litre.

Oil has climbed to its highest level this year, with Brent crude rising $95 per barrel on Tuesday, adding to inflation pressures globally.

Economists have also warned that a rise in alcohol duty at the start of this month could have pushed up prices of wine, and most spirits (although some low-strength drinks became cheaper).

But food price inflation is expected to ease further in August, having slowed in July from the decades-high levels hit earlier in the year. Data provider Kantar has recently reported that UK grocery inflation slowed to its lowest in a year.

A rise in inflation today could put the seal on another UK interest rate rise. The Bank of England will announce tomorrow whether it has raised interest rates for the 15th time in a row, as it continues to battle inflation.

Another central bank, America’s Federal Reserve, will announce its own decision on interest rates tonight. The Fed is expected to leave US interest rates on hold, while it assesses the impact of its earlier rate rises.

The agenda

  • 7am BST: UK inflation report for August

  • 9.30am BST: UK house price and rental indices for July

  • 12pm BST: US weekly mortgage applications

  • 7pm BST: US Federal Reserve interest rate decision

  • 7.30pm BST: US Federal Reserve press conference

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