Consumer price inflation slowed to 4.6 per cent in the year to October, lower than forecasts of 4.8 per cent and down from 6.7 per cent in September, the Office for National Statistics said on Wednesday.
Core inflation, which excludes energy and food prices, and services inflation have been keenly watched by the Bank of England’s rate setters, and both also fell during the month.
The Bank of England has cautioned that base rate will remain elevated for some time
A softer inflation print has encouraged growing expectations the BoE will proceed with as many as three rate cuts next year, following evidence of a loosening jobs market, falling wage growth and weaker economic output.
Danni Hewson, head of financial analysis at AJ Bell, said: ‘Market expectation that we have reached peak interest rates has solidified today and only 3 per cent think the Bank of England will hike rates when it meets next month.
‘Forty per cent expect rates will start to fall in May next year, getting as low as 4.25 per cent by the end of the year, and that expectation has already begun to filter through to lenders.’
Thomas Pugh, economist at RSM UK, added: ‘This is unambiguously positive news for the broader economy, and justifies the MPCs decision to keep interest rates on hold at 5.25 per cent.
‘Indeed, inflation is now 0.3 percentage points below the forecast the MPC made in August.
‘Inflation will probably hover around current levels for the rest of the year, before taking another step down in the first half of next year. However, the second half of the journey down inflation mountain will be tougher.’
While forecasters expect a third consecutive pause at the BoE’s December meeting, inflation still remains well above the BoE’s target of 2 per cent and will likely say elevated deep into next year.
Pugh cautioned this will likely require interest rates to remain in ‘restrictive territory’ for some time, but forecast the BoE’s first cut in the third quarter of 2024.
Evidence of slowing UK wage growth on Tuesday also helped drive expectations of looming interest rate cuts.
Wage growth before bonuses, a factor that had been of particular concern to the BoE and its fight against inflation, stood at 7.7 per cent in the three months to September, down from 7.9 per cent in the previous quarter.
CPI falls to 4.6% in October, down from 6.7% and below forecasts of 4.8%
The figure lies well above consumer price inflation but adds to a weaker economic outlook and a softening labour market as evidence the BoE’s base rate hiking cycle is having the desired impact.
Rob Morgan, chief investment analyst at wealth management firm Charles Stanley, said: ‘Wage growth is one of the key considerations for the BoE when it comes to setting interest rates.
‘The persistence of pay growth will cause the BoE some concern that the fires of inflation won’t be easily quelled, and that interest rates will have to remain higher for longer.’
Easing wages combined with a softening labour market, with jobless claims up by around 18,000 for the quarter, ‘should satisfy’ the BoE that ‘it just needs to be patient in order to see wage growth and inflation return to more normal levels, rather than resuming rate hikes’, Pugh added.
Confidence is growing that the BoE’s hiking cycle has already peaked and Governor Andrew Bailey has been at pains to reiterate that it is too soon to be thinking about rate cuts.
Private sector wage growth has been keenly watched by Bank of England rate setters
Three base rate cuts forecast for 2024
Despite this, the market is still pricing as many as three base rate cuts in for next year with the first coming in May, Pantheon Macroeconomics data shows.
Adding to the urgency for potential future cuts, Pantheon forecasts the UK economy will be weaker, inflation will fall more quickly and unemployment will be higher than the BoE expects in the year ahead.
Chief UK economist at Pantheon Macroeconomics Samuel Tombs said: ‘We’ve seen quite a big shift in market expectations for base rate over the past few weeks.
‘This was absolutely not the message the MPC wanted to give in its monetary policy report… it was signalling that inflation would be too high in the medium term.’
He added that, should the bank keep interest rates at their current level throughout this year, ‘effective’ interest rates and mortgage rates – borrowing costs when taking into account compounding – will rise, putting further pressure on households and the broader economy.
Change of direction: Markets now expect as many as three rate cuts next year, according to analysts at Pantheon Macroeconomics
Pantheon predicts ‘effective’ mortgage rates will continue to climb if base rate stays at 5.25%
Developed markets economist at ING, James Smith, pointed to private sector pay, which was unchanged in September.
‘If you compare the most recent three-month period to the three months prior, the rate of growth has slowed a lot,’ he said.
‘That’s a trend we expect to continue. If you try to produce a model of wage growth, typically the main drivers right now are either inflation expectations or labour market tightness… both are easing rapidly.
‘All of that suggests the Bank’s forecast for private sector wage growth to hit 6.6 per cent in March appears to be on track, and if anything, might be beaten on the downside.
‘We think these figures can reach the 4 to 4.5 per cent area by next summer, and that might be one of the catalysts for rate cuts to begin in August.’
The BoE looks set to be wrongfooted on CPI again next year
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