Inflation in the UK has fallen to its lowest level in three and a half years, giving a pre-budget boost to Rachel Reeves as expectations grow for the Bank of England to cut interest rates.
Figures from the Office for National Statistics show the consumer prices index dropped sharply to 1.7%, down from 2.2% in August, in a bigger than expected fall than anticipated in financial markets driven by lower air fares and petrol prices.
It is the first time headline inflation has dropped below the central bank’s 2% target since April 2021, giving positive news to the chancellor before her set-piece tax and spending event in two weeks’ time.
Reeves has said Labour’s first budget since 2010 will focus on three key objectives: protecting household incomes, repairing public services, and fixing the foundations of the economy with investment in infrastructure. The chancellor has said low and stable inflation is key to her first goal.
The pound fell against the US dollar and the euro on international currency markets, while UK government borrowing costs fell in anticipation of the Bank cutting interest rates.
Darren Jones, the chief secretary to the Treasury, said: “It will be welcome news for millions of families that inflation is below 2%. However, there is still more to do to protect working people, which is why we are focused on bringing back growth and restoring economic stability to deliver on the promise of change.”
The latest snapshot showed petrol and diesel prices fell on the month amid lower crude oil prices, which also helped to bring down the cost of raw materials for businesses. The declines were partly offset by the rising price of food and non-alcoholic drinks.
Economists said the fall in inflation would add to the pressure on the Bank to cut interest rates after figures on Tuesday highlighted a slowdown in the jobs market. Policymakers are expected to reduce borrowing costs by a quarter of a percentage point in November to 4.75%.
UK inflation has been on a downward trajectory since hitting a peak of 11.1% in October 2022. However, investors warned that September’s decline could be reversed after a rise in Ofgem’s energy price cap for households in Great Britain at the start of this month.
Suren Thiru, the economics director at the Institute of Chartered Accountants in England and Wales, said: “Though the stars are aligning for a November rate cut, the upcoming budget is the final hurdle as rate setters will want to assess the inflationary impact of any measures announced before loosening policy again.”
September’s inflation reading is also used by the government to set the annual increase in benefits, meaning millions of households will lose out from a lower than expected figure while the Treasury benefits.
However, the state pension will rise by twice as fast because Labour has committed to the “triple lock”, which guarantees a rise by whichever is highest out of inflation, earnings growth, or 2.5%. Figures published on Tuesday showing wage growth of 4.1% mean the state pension should rise by about £460 next spring.
Lalitha Try, an economist at the Resolution Foundation, said the temporary fall in inflation below 2% was “badly timed” for millions of households who stand to lose out on about £74 next spring relative to using August’s inflation reading.
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“The government needs to address the age divide in benefits which has left working-age support fall further behind rising wages and living standards,” she added.
While lower inflation and borrowing costs could benefit the public finances, if sustained, it could also reflect weakness in the UK economy, undermining the exchequer and Labour’s primary mission to reboot growth.
Reeves has warned that the £22bn hole in the public finances Labour says it inherited from the Conservatives will persist over the next five years. The BBC is reporting that the chancellor is looking to make tax rises and spending cuts worth £40bn at the budget to balance the books.
However, she remains under pressure to boost living standards and repair public services. Paul Nowak, the general secretary of the TUC, said: “Households are still hurting, and families need a fresh start.
“With CPI now below target and GDP growth at just 1% for the last 12 months, this month’s budget is an urgently needed opportunity to unleash a new era of growth to help us repair and rebuild our economy and our country.”