Cooling inflation lifts rate hopes but back-to-back cuts seen unlikely

(Alliance News) - Softer-than-expected UK consumer price inflation figures on Wednesday raised the prospect of back-to-back interest rate cuts, although November is still viewed the more likely timing for the Bank of England's next move.

On Wednesday, the Office for National Statistics reported that annual consumer price index inflation in the UK increased to 2.2% in July from 2.0% in June.

However, this was short of the increase to 2.3% that had been expected by FXStreet-cited market consensus.

It marks the first time annual CPI inflation accelerated since December, when it increased to 4.0% from 3.9% in November.

On a monthly basis, prices declined by 0.2% in July, compared to an increase of 0.1% in June from May.

Annual core CPI, excluding energy, food, alcohol and tobacco, rose by 3.3% in July 2024, easing from a 3.5% rise in June.

Services inflation, a closely watched gauge, slowed more than expected to 5.2% in July from 5.7% in June, the lowest since June 2022. Analysts had expected services inflation to slow to just 5.5%.

Matthew Ryan at Ebury said the "mild miss" in the inflation data has seen traders price in a moderately higher chance of another Bank of England interest rate cut as soon as its next meeting in September.

"While the headline inflation number actually rose last month, the core inflation rate eased to another three-year low, and there was an unexpectedly sharp drop in services inflation, which fell to its lowest level since June 2022," he noted.

"The latter will be particularly encouraging news for Bank of England officials, which have long expressed dismay over stickiness in price pressures in this critical sector."

Ryan doesn't think there is enough evidence to encourage the Monetary Policy Committee to deliver back-to-back cuts, particularly given the cautious tone of the bank's communications at its August meeting.

He instead expects the BoE to hold rates steady in September, while delivering a "dovish set of remarks that makes it crystal clear to markets that a second rate reduction is on the way in November".

But Sanjay Raja, chief UK economist, Deutsche Bank thinks a September rate cut "should no longer be off the table".

"We will get another CPI report ahead of the September decision. The next round of inflation and labour market data will be crucial in deciding whether the MPC could push through a September rate cut. While not our base case, the odds of a back-to-back rate cut are on the rise," he remarked.

Goldman Sachs agreed. "While our baseline remains that the [BoE] will cut at a quarterly pace, with the next policy rate reduction coming in November, today's print further skews the risks around our baseline towards a faster pace. We view a cut in September as possible if the domestic data continues to come in on the weaker side."

Rob Wood at Pantheon Macroeconomics sounded a note of caution, explaining that the downside surprise in services inflation was driven by volatile hotel prices. Air fares were also weaker than predicted, he noted. Wood expects both downside surprises will likely reverse, at least partially, in August.

He expects inflation to rise to 2.4% in August as a weak services inflation rise in 2023 drops out of the annual inflation comparison while airfares surge to reflect school holiday prices and hotel prices likely rebound a little.

Wood doesn't think there is enough here to push the MPC into cutting rates again in September.

"We expect rate setters to wait until November for the next Bank Rate cut. We look for three more cuts next year," he added.

Peel Hunt's Kallum Pickering stuck with his call for a cut in November.

"As long as broad price pressures remain under control as other forward-looking indicators suggest, inflation should remain sufficiently close to the BoE's target over coming quarters for a continued gradual easing of monetary policy - even if GDP and employment data surprise to the upside."

Pickering continues to look for the BoE to cut by another 25 basis points in November, to followed by four further 25bp cuts in 2025 to take the bank rate to 3.75% by year-end.

By Jeremy Cutler, Alliance News reporter

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