UK Inflation Drops to 2.3%: Prompting Potential August Interest Rate Cut

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UK inflation has plummeted to its lowest level in nearly three years, creating speculation about a potential interest rate cut by the Bank of England this August.

The Office for National Statistics (ONS) reported a sharp decline in inflation to 2.3% in the year to April, down from 3.2% in the previous month. This figure surpassed City analysts’ and the Bank of England’s forecasts of 2.1%, indicating stronger-than-expected economic relief.

Before the data release, there was ambiguity regarding whether the Bank of England would cut interest rates in its June or August meetings. The unexpectedly robust inflation figure has now led City analysts to lean towards an August rate cut.

The significant drop in inflation was attributed to slower growth in energy and food prices, with additional easing in tobacco prices. Food inflation fell to 2.9%, its lowest since November 2021, from a previous high of around 20%.

Prime Minister Rishi Sunak welcomed the news, stating, “Today marks a major moment for the economy, with inflation back to normal. This is proof that the plan is working and that the difficult decisions we have taken are paying off. Brighter days are ahead but only if we stick to the plan to improve economic security and opportunity for everyone.”

April’s inflation rate is now at its slowest pace since July 2021, dropping from a peak of 11.1% in October 2022—a 42-year high. The energy regulator Ofgem’s decision to lower the cap on average annual household energy bills by 12% in April also helped curb headline inflation.

Grant Fitzner, ONS’s chief economist, commented, “There was another large fall in annual inflation led by lower electricity and gas prices, due to the reduction in the Ofgem energy price cap. Tobacco prices also helped pull down the rate, with no duty changes announced in the budget. Meanwhile, food price inflation saw further falls over the year. These falls were partially offset by a small uptick in petrol prices.”

The fall in inflation, nearing the Bank of England’s 2% target, suggests an end to the worst of the UK’s cost-of-living crisis and indicates an accelerating economy.

Britain exited a brief recession at the beginning of the year, with growth accelerating to 0.6% in the first quarter. Sunak plans to highlight economic recovery as a cornerstone of the Conservative Party’s general election campaign.

This week, the International Monetary Fund revised its GDP growth forecast for the UK this year to 0.7%, up from 0.5%. However, it advised Chancellor Jeremy Hunt to refrain from further tax cuts to avoid straining public finances. The IMF also indicated that the Bank of England could cut rates three times this year, each by a quarter point.

The UK’s inflation rate now stands lower than that of the United States (3.4%) and the eurozone (2.4%), placing Britain third in the OECD for the largest price surge.

Despite the improved inflation reading, which exceeded the Bank of England’s projections, the possibility of delaying a rate cut until August remains. Sterling surged against the US dollar following the new data.

Services inflation, a key indicator for the Bank of England in assessing domestic price pressures, dropped to 5.9% from 6% in March, though it remains above the central bank’s forecasts. Core inflation, excluding volatile food and energy prices, decreased to 3.9% from 4.2%.

While the reduction in services inflation indicates a cooling of homegrown price pressures, it still surpasses the Bank of England’s projections, possibly leading some members of the Monetary Policy Committee to hesitate on a rate cut next month.

The Committee, consisting of nine members, has stressed that services inflation and wage growth must decline before they can vote to lower borrowing costs. The base rate has risen to 5.25%, a 16-year high, from 0.1%, with the last rate cut occurring in March 2020.

Tomasz Wieladek, Chief European Economist at T. Rowe Price, said, “Although there is some evidence that services inflation is falling gradually, today’s data will likely prevent a cut in June.”

Paul Dales, Chief UK Economist at Capital Economics, added, “It feels as though a cut [in June] now seems very unlikely. Even a cut in August is looking a bit more doubtful.”

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