UK Inflation Posted the Smallest Increase in 2 Years as the BoE Has Refrained from Hikes

UK Inflation Deceleration

UK Inflation has been slowing after the October 2022 multi-decade peak and today's data showed further progress. Headline CPI was flat in October compared to the previous month and rose 4.6% y/y - the slowest pace in two years. The biggest downward contributor was housing and household services, with gas and electricity costs falling substantially. The stickier Core CPI, which excludes energy, food, alcohol and tobacco prices, eased to 5.7% and the lowest since March of last year.

At the start of the year, Prime Minister Rishi Sunak had promised to halve inflation and took a victory lap after today's CPI report, saying he has now "delivered on that pledge" ^[1]. These are definitely welcome news, just two days after the government reshuffle, one year in his tenure.

However, it may be early to declare victory. Despite expecting inflation to "continue to fall sharply", the Bank of England raised its forecasts. It does not project inflation to return below the 2% target until the fourth quarter of 2025, from Q2 of that year previously ^[2]. Furthermore, elevated wages are a problem for policymakers, putting upward pressure on inflation. Tuesday's data revealed some cooling, albeit limited and wage growth remains high. Average weekly earnings rose by 7.9% y/y in the July September period (from 8.2% prior) and 7.7% y/y excluding bonuses.

As such, it may not be that easy for the BoE to avoid further tightening and it has not closed the door to such outcome, having previously underestimated price pressures. Officials maintained rates at 5.25% over the last two meeting after fourteen consecutive hikes and they have good reason to want to stay on the sidelines. Factory and services activity is suppressed, borrowing cost are elevated, money supply has been contracting and the economy is weak. Every new hike increases the risk of breaking something and plunging the economy into a recession. Although not anticipating a recession, the central bank expects GDP to flat-line next year, but this is conditioned on rates staying at around current levels.