The UK's inflation rate plunged to 1.7% in September, down from 2.2% in August, its lowest since April 2021, driven by declining airfares and petrol prices, according to the Office for National Statistics. This steeper-than-expected drop has increased bets on the Bank of England (BOE) cutting interest rates next month, with investors pricing in a 90% chance of two quarter-point rate cuts by the year's end.
This inflation relief comes as a welcome development for finance minister Rachel Reeves ahead of her first budget on October 30. With a less inflationary outlook, Reeves could gain some fiscal flexibility as she navigates tight spending constraints without unsettling investors. However, concerns remain, as KPMG UK's chief economist, Yael Selfin, cautioned that inflation might rebound due to rising oil and energy prices linked to the Middle East conflict, though this may not prevent the BOE from cutting rates.
The drop in core inflation, excluding volatile items like energy and food, to 3.2% from 3.6%, and services inflation to 4.9% from 5.6%, were also below expectations. The BOE had not anticipated such a sharp drop in services inflation, which it closely monitors for domestic price pressure.
Factory-gate prices also fell by 0.7% year-on-year in September, marking the largest decline since October 2020, signaling weaker inflationary pressures ahead.
The upcoming budget and its potential inflationary impacts will be closely watched by the BOE as it considers its next steps on monetary policy.
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