At a glance, last month’s sharp drop in the headline inflation figure to 1.7% tells the Bank of England all it needs to know when it considers whether to cut interest rates next month.
The plunge from 2.2% in August puts the rate of prices growth well below the central bank’s 2% target and back in territory that we last saw in early 2021 – long before the Russian invasion of Ukraine sent energy prices rocketing.
It is also welcome news for Rachel Reeves, signalling that the Labour government is about to enjoy a period of low inflation and lower interest rates, giving her the platform to borrow for investment in this month’s budget without spooking financial markets.
Lower inflation allows the Office for Budget Responsibility (OBR) to forecast lower departmental spending. For instance, September’s inflation rate will set the increase for working-age benefits next April, saving billions from the welfare bill.
As the Bank is now expected to reduce borrowing costs faster, the OBR is also set to cut its outlook for the cost of financing government debt, which ballooned to more than £100bn in the 2023-24 financial year, or almost 10% of total spending.
If Whitehall departments can budget for lower inflation and the Treasury can borrow more cheaply, Reeves has a chance to maintain day-to-day spending in real terms while giving longer-term infrastructure spending a boost in her budget on 30 October.
It is an illustration of how consequential lower inflation can be. Yes, the chancellor will still need to impose some substantial tax rises, but that could now be couched in a broader narrative that is much more optimistic about the UK than was contemplated until now by many economists or even the Treasury.
Much depends on how the OBR views the next five years, and that may not have changed very much since its previous prediction in March. However, the expectation will be that a radical overhaul of the forecasts for inflation and borrowing costs is justified.
An essential factor in any calculation outlook for the cost of borrowing is the response of the Bank of England. Before the latest data, investors were 80% sure of a quarter of a percentage point cut to interest rates to 4.75% when policymakers meet next month.
Afterwards, those odds tightened further to 90% and hopes are now growing that rates could fall more aggressively next year, as the Bank governor, Andrew Bailey, hinted to the Guardian earlier this month should inflation continue tumbling by more than expected.
The financial markets reacted accordingly, with sterling starting to slide on currency markets as soon as the September inflation figure appeared, continuing a fall that has dragged the pound down from $1.34 late last month to below $1.30.
Many of the nine officials on the Bank’s rate-setting monetary policy committee (MPC) are expected to be sceptical of a sustained levelling off in prices. They will point out that the most recent fall in inflation relies on the tumbling oil price and how it feeds through to sectors such as transport.
The Office for National Statistics said the average price of petrol fell by 5.5 pence a litre between August and September 2024 to stand at 136.8p.
MPC members will be spooked that food prices are continuing to rise strongly when they would usually be affected by the falling cost of transport.
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The main indicator of more persistent inflationary trends, the core inflation figure that strips out energy and food because they can be volatile, stood at a much higher rate of 3.2%.
However, wage growth is slowing, indicating a weakening economic outlook that needs a boost from lower borrowing costs.
The oil price is dictated more these days by economic decisions in Beijing than conflict in the Middle East. And China, the world’s largest consumer of oil, is in the midst of a dramatic slowdown brought on by a housing bubble bursting in spectacular fashion.
Across the Atlantic, a boom in US economic growth is coming to an end. And the rest of Europe continues to labour under the twin pressures of the Ukraine war and lower demand from its chief export destinations – China and the US.
It is in this global context that the MPC will consider where next for interest rates, and which adds to the likelihood they will now fall a bit faster than previously expected.
Reeves will lament the lack of drive from the global economy. The compensation is the benefit to the public finances and her plans to claw back more than a decade of lost public investment under the Conservatives.