UK inflation rate shows unexpected fall to 6.7% in August

UK inflation has fallen to the lowest level since February last year, surprising forecasters and raising the chances of the Bank of England leaving interest rates unchanged tomorrow for the first time in nearly two years.

Prices increased 6.7 per cent over the year to August, down from July’s 6.8 per cent growth rate, according to the Office for National Statistics (ONS). The number was well below City analysts’ expectations of 7.1 per cent and the Bank of England’s latest projections.

A marked easing in food prices, air fares and accommodation costs pushed the inflation rate lower.

Grant Fitzner, chief economist at the ONS, said: “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.”

Measures of underlying inflation also fell sharply in August. Services and core inflation, which members of the Bank’s rate-setting monetary policy committee (MPC) monitor closely, dropped to 6.8 per cent from 7.4 per cent and to 6.2 per cent from 6.9 per cent respectively, the ONS said.

Jeremy Hunt, the chancellor, said: “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.”

Money markets before the inflation numbers were released expected the Bank of England to elect for a 0.25 percentage point rise tomorrow. Such a move would mark the 15th straight increase.

Sterling dropped after the inflation data. It fell to $1.2339 against the dollar, down 0.4 per cent, as the markets weighed up what it would mean for future interest rates. Yields on short-dated UK government bonds also fell, with the yield on 2-year gilts sliding from 4.7 per cent to 4.6 per cent after the data was published. The yield on the benchmark 10-year gilt fell from 4.34 per cent to 4.25 per cent.

This month’s interest rate decision has been billed as the toughest to call since the Bank embarked on the most aggressive run of rate rises in over three decades in December 2021.

Data since the MPC’s last meeting in August has painted a murky picture of the UK economy. Growth has shifted into reverse, unemployment has accelerated faster than predicted and employment volumes have contracted sharply, triggering calls for the Bank to leave the base rate unchanged.

On the flip side, private sector wages rose more than 8 per cent in the three months to July, while underlying measures of inflation are still elevated. Members of The Times’s shadow MPC voted 7-2 in favour of a 0.25 percentage point rise.

Financial markets agreed, but think any such rise tomorrow will bring the Bank’s tightening campaign to an end. Interest rate cuts are not expected until the end of next year.

Simon French, chief economist at Panmure Gordon investment bank, said on Twitter/X: “Financial markets now seeing UK rate decision as 50/50 tomorrow. Having been 80/20 in favour of a hike first thing.”

The Bank is ultimately tasked with keeping inflation stable at 2 per cent, a feat it has not achieved since July 2021. The central bank has been raising interest rates for nearly two years to rein in consumer spending and borrowing in a tactic that, in theory, tames price growth.

Paul Dales, chief UK economist at Capital Economics, said in a note to clients that he still expected the MPC to raise rates tomorrow despite the surprise fall. “The unexpected declines in CPI inflation and services inflation probably won’t be enough to prevent the Bank of England from raising interest rates tomorrow. But it supports our view that that will be the last hike,” he wrote.

Yael Selfin, chief economist at KPMG, described the data as “positive” but still expected the MPC to raise rates. “It would be surprising to see the BoE doing anything other than raising interest rates by 25 basis points tomorrow,” she said.

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UK inflation rate shows unexpected fall to 6.7% in August