UK inflation: Will a bigger-than-expected fall prompt an interest rate cut?

An unexpected dip in UK inflation has been branded the “calm before the storm” ahead of increases in national insurance, the minimum wage and energy and council tax bills.

Official figures showing that the annual rate of consumer prices index (CPI) inflation fell to 2.8 per cent in February from 3 per cent in January will be welcomed by both the Treasury and the Bank of England. The latest reading came in slightly below the 2.9 per cent expected by analysts and was aided by the prices of clothes and shoes falling for the first time in more than three years, according to the Office for National Statistics (ONS).

The latest figures mean that, across the board, the cost of living is still rising for millions of households, despite some deflationary feed through on certain food and non-food items, while inflation remains above the central bank’s long-term 2 per cent target. It is, however, well below the peak of 11.1 per cent hit in autumn 2022.

Shoppers will have noticed that while some items have come down in price in recent months many are still rising.

Jeremy Batstone-Carr, European strategist at Raymond James Investment Services, said February’s dip was likely to be the “calm before the storm for UK inflation”.

He noted: “Though a welcome respite, this will likely do little to ease concerns that price pressures are contained and will not hold at prevailing levels for long. Another upward leg is highly likely soon.

“The [Bank of England’s] monetary policy committee will be most concerned about the notable increase in supermarket food prices, despite subdued input costs. Some parties infer that consumer-facing companies have increased prices in an attempt to pass on the costs from April’s scheduled increase in the minimum wage and national insurance contributions.”

Prices typically rise between January and February, when Christmas sales end and new ranges are launched. Women’s clothes, accessories such as hats and scarves, and children's clothing all helped bring down the inflation rate last month. Housing inflation, including rents, also slowed in February, as did admission prices for live music.

Higher energy bills are among the inflationary pressures set to feed through in April.

On the flip side, alcohol and tobacco prices rose, following a tax increase on bottled alcoholic drinks at the beginning of the month.

ONS chief economist Grant Fitzner said: “Inflation eased in February. Clothing prices, particularly for women’s clothes, was the biggest driver for this month’s fall. This was only partially offset by small increases, for example, from alcoholic drinks.”

Overall prices for clothing and footwear fell by 0.6 per cent in the 12 months to February - which the ONS noted was the first drop since October 2021.

Last week, saw the Bank of England vote to keep the bank base rate at 4.5 per cent while they assess the impact of economic and political developments around the world.

The bank’s nine-strong monetary policy committee (MPC) said there were risks to the economic outlook for several countries, including the UK, and uncertainties about how the policy changes could affect inflation. It stressed it was a “rapidly evolving situation, which it would monitor closely and assess further” at the rate-setting committee’s next meeting on May 8. A further five meetings are then due to be held before the end of 2025 - in June, August, September, November and December.

Luke Bartholomew, deputy chief economist at Scottish investment heavyweight Aberdeen, said a further cut in interest rates was likely at May’s gathering.

“Both the Bank of England and the Chancellor will be somewhat relieved by the drop in headline inflation,” he said. “However, inflation is still running well ahead of target and is still likely to increase later this year. So this report does not fundamentally change the outlook for inflation, but it should keep the path clear for another interest rate cut in May.”

Thomas Pugh, economist at audit, tax and consulting firm RSM UK, described the fall in the headline rate of inflation as a “temporary slowdown” with the likelihood that it would “lurch higher” in April as annual price resets and Budget tax rises take effect.

“We already think that inflation will peak at close to 4 per cent in the summer, but the risk is that firms are more aggressive in passing on rising employment costs and instead of gradually falling, services inflation remains steady. In that case, even two more rate cuts from the MPC would look ambitious,” he added.

“While a drop in headline inflation is good news for the Bank of England, it’s unlikely to make much difference to the outlook for interest rates for two reasons. Firstly, services inflation, which is more reflective of price pressures in the domestic economy, was flat at 5 per cent. Secondly, the MPC will be much more concerned about how inflation is looking after April, when the tax rises contained in the Budget will take effect, than how inflation was back in February.”

Anna Leach, chief economist at the Institute of Directors, said: “With the balance of inflationary pressures pretty stable at an elevated level in the near-term, there remains limited space for interest rates to fall this year.

“For the Chancellor, debt interest payments will continue to constrain the public purse, meaning every other penny of government spending will need to work that bit harder to deliver savings and productivity improvements, both for the public sector and the broader economy.”

Responding to the latest data, chief secretary to the Treasury, Darren Jones, said: “Our number one mission is kickstarting growth to raise living standards for working people, that is why we are protecting working people’s payslips from higher taxes.”

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