UK inflation rate falls below target to 1.7%

UK inflation slid to its lowest level since April 2021 last month and below the Bank of England’s 2 per cent target, increasing the chances of an imminent cut to interest rates.
The rate of price growth in the UK economy slipped to 1.7 per cent on an annual basis in September from 2.2 per cent in the previous month, according to the Office for National Statistics (ONS).
City analysts had expected the rate to drop to 1.9 per cent, while the Bank of England had forecast a smaller decline to 2.1 per cent.
The drop was driven by lower air fares and petrol prices in September compared with the same month last year. This was offset by growth in food and non-alcoholic beverages inflation, which rose to 1.8 per cent from 1.3 per cent, the first jump since March 2023. Food inflation peaked at nearly 20 per cent that month.
The pound dipped against the US dollar on the news, falling by 0.62 per cent to below $1.30, and fell by 0.49 per cent against the euro to €1.194. The yield on the ten-year UK government bond slid 1.8 per cent to 4.1 per cent on the prospect of more rate cuts and yield on the more rate-sensitive two-year bond fell 2.5 per cent to 4.03 per cent.
• What does the fall in inflation mean for borrowers and savers?
Darren Jones, chief secretary to the Treasury, said: “It will be welcome news for millions of families that inflation is below 2 per cent. However, there is still more to do to protect working people, which is why we are focused on bringing back growth and restoring economic stability to deliver on the promise of change.”
The rapid fall in inflation could provide a boost to Rachel Reeves before her first budget on October 30 by increasing market expectations for faster interest rate cuts by the Bank of England.
The chancellor told a cabinet meeting on Tuesday that she intended to plug a £40 billion funding gap at the fiscal event, which could involve capital gains tax increases and subjecting employers’ pension contributions to national insurance.
Grant Fitzner, chief economist at the ONS, said: “Inflation eased in September to its lowest annual rate in over three years. Lower air fares and petrol prices were the biggest driver for this month’s fall.
“These were partially offset by increases for food and non-alcoholic drinks, the first time that food price inflation has strengthened since early last year. Meanwhile, the cost of raw materials for businesses fell again, driving by lower crude oil prices.
• UK inflation: What does drop in CPI mean for the budget?
September’s inflation figure is used to determine the rise in benefit payments to households. A lower than anticipated figure will put downward pressure on welfare payments but could curb the government’s tax income from “fiscal drag”, where workers are pushed up the tax ladder after they receive a wage increase.
The figure also feeds into the pensions “triple lock” calculation, which sees pensions rise by whichever is greatest out of earnings growth, inflation and 2.5 per cent. The state pension is poised to jump by £460 next year thanks to elevated wage growth of about 4 per cent in the three months to July.
The slide in the rate to below the 2 per cent target represents another step in the UK’s battle against inflation. Price growth surged to a more than 40-year high of 11.1 per cent in October 2022, fuelled by rising energy prices in the wake of Russia’s invasion of Ukraine.
However, inflation had started to rise before the invasion, hitting 5.4 per cent by the end of 2021 thanks to constrained supply colliding with a resurgence in consumer demand after the end of Covid-19 lockdowns. Since 2021 prices have climbed by more than a fifth.
In response to this increase, the Bank of England started lifting interest rates in December 2021 before cutting them for the first time in more than four years in August this year by 25 basis points to 5 per cent.
Below-target inflation in September will strengthen the case for the central bank to lower borrowing costs at its next meeting on November 7, a move that traders had already priced in.
Paul Dales, chief UK economist at Capital Economics, a consultancy, said that a rate cut next month already seemed “nailed on” before the September inflation figures, but added: “The chances of that being immediately followed by another 25 basis points cut at the following meeting in December has just gone up.”
Thomas Pugh, an economist at RSM UK, said the data provided “clear evidence that disinflation is continuing to move through the economy at pace, and should reassure the Bank of England that it can move to cut interest rates more aggressively without stoking higher inflation”.
There are contrasting views among the Bank’s nine-strong monetary policy committee (MPC), which convenes every six weeks or so to set the base rate, over the persistence of inflation and the pace at which monetary policy should be relaxed.
Earlier this month Andrew Bailey, the Bank’s governor, said the central bank could be a “bit more aggressive” in easing policy. In contrast Huw Pill, its chief economist, said that rates might need to stay higher to treat lasting inflationary pressures.
Services inflation, a closely watched metric by the MPC, fell sharply to 4.9 per cent in September, down from 5.6 per cent. Core inflation, which removes food and energy price movements, declined to 3.2 per cent from 3.6 per cent in August.
An array of opinions on the severity of price pressures among the MPC indicates that upcoming votes on interest rates will be tightly contested. In August the panel voted narrowly 5-4 in favour of cutting rates by a quarter point.
For the chancellor, the latest inflation figures were unbridled good news in advance of her inaugural budget on October 30. On several fronts, she can credibly claim that they will fortify the public finances.
For starters, September’s inflation rate — 1.7 per cent, well below the Bank of England’s 2 per cent target — is used to determine the increase in working age benefits payments next April. The figure was below expectations, trimming the welfare bill.
Rachel Reeves may yield, however, to those who have pointed out that, under the triple-lock, pensions are set to rise by more than twice as much as welfare payments. She could lift benefit payments by 2.5 per cent as a compromise.
Second, inflation is falling quicker than the Bank of England had expected. Threadneedle Street had thought that the rate would slip to 2.1 per cent in September. Crucially, services inflation, which underpins ratesetters’ thinking, fell to 4.9 per cent, well below the Bank’s forecast of 5.5 per cent.
City analysts reckon that a rate cut is nailed on at the Bank’s next meeting on November 7 and that the chances of this being followed by another quarter-point drop in December has intensified. Rates were lowered for the first time in four years in August and stand at 5 per cent.
Rob Wood, chief UK economist at Pantheon Macroeconomics, a consultancy, said: “A 25 basis-point November rate cut is a racing certainty, and either a consecutive cut in December or a 50 basis-point reduction in November looks like a much better bet.”
Expectations among investors for a quicker rate-cutting cycle would lead the Office for Budget Responsibility (OBR) to provide the chancellor with greater scope to scale back tax rises or spending cuts.
The OBR judges how much money the government must allocate to interest payments by using the “market curve” — an average of investors’ expectations for the trajectory of interest rates in the coming years. If this curve steps down, so does the debt interest bill, provided that the government does not let borrowing get way out of hand.
Reeves told a cabinet meeting on Tuesday that measures announced at the budget could amount to £40 billion, larger than the £22 billion “fiscal black hole” we’ve heard so much about.
Government spending, which exceeded forecasts this year under the Conservatives largely thanks to elevated expenditure on the asylum system, could also be restrained by weaker price growth. Civil servants may demand lower wage settlements as cost of living pressures recede. The price of running the government’s day-to-day activities could also ease.
• Which taxes are most likely to go up in the budget?
On the other hand, the boost to the public finances from “fiscal drag”, where workers are thrown up the tax ladder when they receive a pay rise because thresholds are frozen, will not bring in as much if inflation remains lower than projected.
Taxes will rise at the budget, the chancellor has made that clear, and these inflation numbers won’t change that.
However, a step up in public investment, as Reeves has signalled will happen, should expand the UK’s capacity to make goods and services which, in the long-run, can boost growth and shield against inflation.