UK inflation data looks like good news, but will the Bank of England be persuaded?
- UK inflation dropped to a rate of 3.4% in February.
- The OBR says inflation will average 2.2% for 2024
- Two and 10 year gilt yields did not move significantly
The UK government will be breathing a small sigh of relief, after the latest CPI data showed inflation dropping to 3.4%. This was lower than expected and it is expected to drop still further as the energy price cap falls in April. It puts increasing pressure on the Bank of England to cut rates sooner rather than later to shore up the UK’s lacklustre economy.
Good prices are falling. The services sector saw a more muted drop, but recent wages data gave some hope that inflationary pressure would start to come down more quickly there as well. The expectation from the Office for Budget Responsibility is that inflation will average just 2.2% in 2024.
This seems like a good moment to cut rates, but with green shoots appearing in the UK economy, the Bank of England may feel it has no need to move. It continues to talk tough on rate cuts, suggesting investors should not expect any imminent moves. Bond markets seem inclined to agree and the two and 10 year gilt yields were largely unmoved on the day.
Another problem is that inflation still looks persistent in the US. The latest data showed shelter (which includes rents, hotel and motel stays) and energy costs stubbornly high. Areas such as car insurance are also seeing prices rise. With the economy and jobs market still buoyant, there appears little catalyst for inflationary pressures to subside.
There is a question as to whether the UK will feel sufficiently emboldened to move first on interest rates. This could put the pound under unwelcome pressure, and raise prices for imported goods. However, the UK has coped with a strong Dollar for some time, and there is a question of whether other factors, such as the size of the US deficit, may prove a stronger force than marginal differences in rate policy. It is also possible that the Eurozone will go first on interest rates.
The government will wish the Bank of England could be persuaded otherwise. There are still a lot of mortgage holders who need to roll over their debt as fixed rate terms expire. This is likely to put persistent pressure on household spending, and will continue to exert a downward effect on the economy at a time when the government would like people to feel richer.
On balance, the drop in inflation is better than the alternative. However, it is unlikely to move the dial for the Bank of England or for UK households. There is unlikely to be a pre-election bonus for the government.
