UK reaction: Some volatility at play, but broader pressures are easing

Today’s CPI data all but seal the deal for an additional cut to Bank Rate at November’s Bank of England meeting. The headline rate dropped to cyclical low of 1.7% - markets had anticipated a drop to 1.9% - from 2.2%, reflecting a broad-based slowdown across goods and services. Indeed, CPI goods inflation dropped to -1.4% in September, from -0.9%, while services CPI inflation dropped to 4.9% – over a two-year low – from 5.6% August. Core CPI inflation slowed by more than expected as a result, to 3.2%, from 3.6%.

The sharper than expected slowdown in services CPI inflation partly reflected transport CPI inflation which fell to -2.2% in September, from 1.3% in August. Indeed, the volatile airfares component plummeted, with prices for domestic, European and long-haul flights falling by a chunky 34.8% on the month. Prices usually decline between August and September as the school holidays wind up, but this was the fifth largest fall since the series began in 2001. Note, though, that the sharp drop in September is largely due to a surge in prices in August. The decline in motor fuel prices also gained momentum, with lower petrol and diesel prices leading to a 10.4% year-on-year decline. The downward contribution from transport will likely ease in October, however, as the sharp drop in oil prices in September partially reversed and the recent volatility in airfares peters out.

The main upward contribution, meanwhile, was food CPI inflation which picked up to 1.9%, from 1.3%, marking an end to the downward trend since March 2023. Normality in this area of prices has likely resumed; we do not expect to see a sustained increase in food inflation, but we doubt it will fall much further either. Elsewhere, private school fees increased by 5.1% on the month, a smaller rise than in September 2023, where fees went up by 7.5%. Note, though, that this number doesn’t reflect the addition of VAT which is set to be introduced in January. As a result, the ONS will break convention and measure school fees again in January.

Looking ahead, the headline rate will start to increase again in Q4, as the drag from energy eases. Indeed, the Ofgem Energy Price Cap is set to rise by 10% in October and pump prices look set to edge up once more. Alcohol and tobacco duties may also increase in the upcoming Budget on October 30^th, which could impact short term headline rates, while the ongoing fuel duty freeze looks set to unwind in the Spring. More generally, these increases will likely be offset elsewhere particularly over the medium term, with loosening labour market conditions putting downward pressure on wage growth, for instance. Taking a step back, we continue to see just one cut in November this year, leaving Bank Rate at 4.75% by year -end. But the outcome of the Budget will be key in determining the pace of loosening further ahead, and if downward surprises continue, we think a December cut is definitely in play.