UK inflation hits lowest rate since 2021 at 3.4 percent

LONDON: UK inflation has fallen more than forecast to 3.4 per cent, the lowest since 2021, indicating that summer interest rate cuts remain on track and providing relief for Rishi Sunak’s embattled government.

The rise in consumer prices for the year to February was below both the 3.5 per cent predicted by economists in a Reuters poll and January’s 4 per cent rate.

Wednesday’s figures, which came a day before the Bank of England’s Monetary Policy Committee meets, also showed falls in service price and food inflation.

“Price pressures in the UK economy are clearly easing faster than expected,” said Thomas Pugh, an economist at consultancy RSM UK. “That will provide excellent cover for the MPC to pivot and start cutting interest rates.”

The BoE predicted in February that inflation was set to drop to its 2 per cent target in the second quarter this year due to falling energy costs, and Wednesday’s Office for National Statistics figures leave it on track to reach that level as soon as April.

Prices in swaps markets signalled traders’ belief that the BoE remains likely to cut benchmark rates from their 16-year high of 5.25 per cent by August at the latest, although the bank is expected to keep rates on hold at Thursday’s meeting.

Traders price the probability of a quarter-point cut by June at about 60 per cent, roughly the same as before the data release. Two-year gilt yields, which reflect interest rate expectations, were down 0.01 percentage points at 4.25 per cent.

Sterling also nudged lower, falling 0.2 per cent against the dollar at $1.2696. The fall in consumer prices inflation to its lowest since September 2021 was seized upon by the Conservative government, which remains about 20 points behind the opposition Labour party in the opinion polls.

The ruling party, which has contended over the past two weeks with a scandal over racist remarks by a party donor and an underwhelming public response to national insurance cuts, is keen to depict itself as the best steward of the nation’s economy.

“The plan is working,” said chancellor Jeremy Hunt. “Inflation has not just fallen decisively but is forecast to hit the 2 per cent target within months.”

February’s 3.4 per cent rise in CPI compared with a peak of 11.1 per cent in October 2022. But Rachel Reeves, shadow chancellor, said working people remained worse off. “Prices are still high, the tax burden is the highest it has been in 70 years and mortgage payments are going up,” she said.

The figures showed that core inflation, which excludes food and energy, fell to 4.5 per cent in February from 5.1 per cent in January. Analysts had predicted a reading of 4.6 per cent.

But arguments for the BoE’s tough monetary policy stance hinge on the outlook for services inflation, which officials see as a key gauge of domestic pricing pressures as external drivers of inflation such as high fuel prices fade away.

On Wednesday, the ONS said service price inflation eased to 6.1 per cent from 6.5 per cent in January, in line with BoE expectations.

Neville Hill of Hybrid Economics, a consultancy, said that inflation for services was “stickier” than for goods and constituted “a clear risk that overall inflation will remain high, warranting ongoing restrictive monetary policy”.

He added that Wednesday’s figures “will do nothing to assuage those specific concerns”. The central bank is also keenly watching wage increases and other labour market data.

Annual wage growth excluding bonuses inched down to 6.1 per cent in the three months to January in the UK, from 6.2 per cent in the period until December. It remains well above the level that would be comfortable for the BoE.

The MPC has since left rates unchanged since August last year, although its nine members were split three ways when they last met in February.

The US Federal Reserve and European Central Bank have both also signalled they will start reducing rates only when they have enough evidence that inflation is heading durably lower.

Despite the recent inflation slowdown, high prices are still putting pressure on UK living standards.

The latest forecasts from the Office for Budget Responsibility, the independent fiscal watchdog, show that per-person real household disposable incomes will recover their pre-pandemic levels only by 2025-26.

The BoE has said underlying inflation pressures remain too persistent for it to cut interest rates now, although it has signalled that lower borrowing costs are likely later this year.

The BoE thinks inflation -- which peaked above 11% in October 2022 -- will fall back to the central bank's 2% target in the coming months before picking up again slightly. The figures will also be welcomed by Sunak, whose standing has been hit by Britain's cost of living squeeze.

Sunak has sought to take credit for more than halving inflation, although there has been scant sign of an opinion poll boost for his struggling Conservative Party, which lags the opposition Labour Party by around 20 points.

Finance minister Jeremy Hunt said the latest fall in inflation could help the government with its goal of abolishing social security taxes altogether. But any moves would be done only if the government could avoid increasing borrowing or cutting funding for public services.

Earlier this month, Hunt cut the rate of social security contributions for the second time in less than four months.

He also took the unusual step of commenting on what the data might mean for the BoE. "As inflation gets closer to its target that opens the door for the Bank of England to consider bringing down interest rates," Hunt told reporters.

Sunak has said Britain's economy is turning a corner and he is urging voters to stick with his Conservative Party to see his plan through. The Labour Party said prices were still high and that people were worse off after 14 years of Conservative government.