An unexpected fall in inflation to 2.4 per cent in September has eased pressure on the Bank of England to raise rates as Brexit negotiations seemingly reach a conclusion.
The drop in the consumer prices index (CPI) rate of inflation from August’s 2.7 per cent was well below economists’ forecasts of a small rise to 2.8 per cent.
The lower rate was attributed to a drop in prices related to the food & non-alcoholic beverages, transport, recreation & culture, and clothing & footwear sectors with smaller downward effects from other areas.
The largest downward contribution came from food & non-alcoholic beverages where prices fell between August and September 2018 by 0.1 per cent having risen by 0.8 per cent a year earlier.
CPI inflation rate over 5yrs
Source: Office for National Statistics
It comes as the Office for National Statistics revealed regular pay – in nominal terms – had risen by 3.1 per cent the highest rate since October/December 2008 and signalling a real income increase.
“In a reversal of developments last month, CPI surprised consensus on the downside by two-tenths in September, having surprised on the upside by three-tenths in August,” said Royal London Asset Management economist Melanie Baker.
“In coming months, the tight labour market should keep up pressure for pay rises. But, for now, the weaker than expected data today brings the headline inflation figures back into line with Bank of England forecasts from August.”
At the publication of August’s inflation report by the Bank’s Monetary Policy Committee warned that if inflation were to remain elevated, it would be likely to set a course of rate increases to 1.1 per cent over the next three years to meet its 2 per cent CPI target.
Indeed, September’s drop – along with more robust wage growth figures – could give the Bank more room to manoeuvre as Brexit negotiations continue to unfold.
Andrew Wishart, UK economist at consultancy Capital Economics, said the move removes any pressure on the Bank of England to hike interest rates again until it knows the outcome of Brexit negotiations.
Wishart said: “With inflation in line with the Bank’s forecast, and measures of domestically generated cost pressures, such as core inflation and services inflation falling back, this reduces any pressure on the Monetary Policy Committee to act again before it can assess the likely impact of the Brexit negotiations.”
As such, Wishart said the consultancy was next forecasting a rate hike in May – if a Brexit deal is agreed.
However, while the pressure to raise rates has subsided, many Bank watchers believe that it is still likely to press forward with rate hikes as inflationary pressures start to appear within the global economy.
“Today’s release gives the Bank a bit more breathing space,” added Royal London Asset Management’s Baker. “However, with domestic inflationary pressure still likely to pick up in coming quarters, the Bank still looks on track to raise rates next year, assuming some of the Brexit uncertainty is behind us.”
CPI inflation projection based on market interest rate expectations
Source: Bank of England
Hargreaves Lansdown senior economist Ben Brettell said that there were a number of inflationary headwinds starting to appear in the global economy.
“In the UK and across the developed world, inflation looks to be rearing its head again with the global economy growing strongly,” he explained. “This means central banks gradually tightening policy and bringing to a close a decade of cheap money.
“Along with continued tensions between the US and China, this is a key reason for stock market jitters over the past couple of weeks.”
Thomas Wells, manager of the £110.3m Smith & Williamson Global Inflation-Linked Bond fund, said his ‘global worry list’ was “pretty long” highlighting the Federal Reserve’s plans to continue tightening despite the ongoing trade dispute between the US and China.
Another worry for Wells includes higher oil prices, particularly at a time when relations between Saudi Arabia – the world’s largest producer – and the rest of the world have worsened more recently.
Indeed, oil prices have rallied considerably over the past two years with the Bloomberg Brent Crude Sub index up by 52.03 per cent, as the below chart shows.
Performance of index over 2yrs
Source: FE Analytics
“In our view, that is not a recipe for a particularly benign inflation outlook,” he said. “If anything, a period of stagflation cannot be ruled out as economic growth globally appears to be rolling over but inflation itself a lagging indicator, so it could remain resilient for some time yet.”
However, the fall in inflation should also be treated as an opportunity for investors.
“The slower pace of rate rises will be welcomed by equity investors especially when there is so much political and economic uncertainty caused by Brexit and other geopolitical themes,” said Helal Miah, investment research analyst at The Share Centre.
“The slower pace of rate rises should also mean that equity returns are still likely to be superior on a risk-adjusted basis than cash, which is one of the mains reasons why we still believe that investors should still have shares as a significant part of their portfolios.”