UK inflation fall throws BoE a curveball before rates decision

Britain’s high inflation rate unexpectedly slowed, raising the prospect of the Bank of England pausing its long run of interest rates hikes as soon as Thursday.

The pound fell and investors saw a nearly 50-50 chance of rates staying on hold at the BoE’s September meeting after the consumer price index sank to an 18-month low of 6.7 per cent in August.

That was only a small fall from July’s 6.8 per cent but flew in the face of forecasts by economists — and the BoE too — for an increase.

Underlying measures of inflation weakened more sharply, opening up the possibility that BoE Governor Andrew Bailey and his Monetary Policy Committee (MPC) colleagues will keep rates on hold on Thursday after 14 back-to-back increases since December 2021. “The big downside surprise to core inflation throws the Bank of England a major curveball,” Chris Hare, an economist with HSBC, said.

Strong wage growth in recent data meant a rate hike was still the most likely outcome on Thursday but “today’s data raises a risk that the MPC will remain on hold,” he said.

Sterling sank by half a cent to its lowest against the U.S. dollar since May and it also fell against the euro

The slowdown in inflation was driven by a drop in often-volatile hotel prices and air fares, and by food prices rising less than a year ago, the Office for National Statistics said.

That offset a jump in global fuel prices and an increase in a tax on alcoholic drinks.

Britain’s inflation rate has fallen from a peak above 11 per cent last October but even after the latest drop it remained among the highest in Western Europe, topped only by Austria and Iceland in August.

But core inflation — which strips out volatile food and energy prices - fell sharply to 6.2 per cent from 6.9 per cent in July.

Service sector inflation — also closely watched by the BoE — lost some of its steam too, slowing to 6.8 per cent from 7.4 per cent.

Inflation pressures ahead

“Thursday’s Bank of England meeting just got a lot more interesting,” James Smith, an economist at ING, said. “It’s a very close call, but we’re still tempted to say the Bank will follow through with a hike tomorrow.”

He said the expected increase was likely to be the BoE’s last for now.

There were signs of a further weakening of inflation pressure ahead as factory gate prices fell 0.4 per cent in the 12 months to August. Manufacturers’ input prices dropped by 2.3 per cent.