UK CPI Inflation: A Downside Surprise Means More Room for a ‘Skip’ from the Bank of England

“The fall in inflation wasn’t just about food and hotels, and headline inflation is still likely to fall quite a lot further. First, while volatile items like air fares and hotels were partly behind the fall in core inflation, there were other contributors. Second, the rise in energy price inflation from -7.8% to -3.2% in this release should prove temporary. Powerful negative base effects from electricity and gas bills, which rose a lot last October, are likely to pull energy inflation down further in October. Third, input price figures look consistent with further falls in core goods price inflation. Fourth, I still expect a modest recession in the UK and for a looser labour market and well-behaved inflation expectations to help see lower pay growth next year.

“Domestically-driven inflation still looks strong for now, though inflation fell to 6.8% from 7.4% with falls across a number of categories, but that’s clearly still a very high rate of inflation. Pay growth remained strong on the data released last week too, of course, though the labour market figures overall were consistent with a less tight labour market.

“The Bank of England (BoE) has continued to signal that if inflation pressures prove persistent then they will likely tighten monetary policy further. The August BoE staff forecast for the August 2023 CPI figure was 7.1%, hence this figure would be a downside surprise to them in that sense. In the context of still strong domestic inflation pressure, I expect the Bank to hike rates once more by the end of the year. They might choose to keep rates on hold in September and wait for more data and their next forecast round in November, especially in light of some of the recent weak activity data and with this release being a downside surprise. Ultimately though, I think the domestic inflation picture is still too strong for them not to hike a little bit further either tomorrow or in November.”