UK Inflation Drops Below 2% Since 2021, Boosting Reeves Ahead of Budget

Department of Security and Military Strategic Research and Studies 16-10-2024

UK inflation has reached its lowest point in over three years, providing a timely boost for Rachel Reeves as anticipation grows for potential interest rate cuts from the Bank of England.

Recent data from the Office for National Statistics indicates that the consumer prices index fell to 1.7% in September, down from 2.2% in August. This decline exceeded market expectations and was largely driven by decreases in airfares and fuel prices.

This marks the first occasion that inflation has dipped below the Bank of England’s 2% target since April 2021, offering positive news for the chancellor ahead of her significant tax and spending announcement in two weeks.

Reeves has outlined that Labour’s first budget since 2010 will concentrate on three main objectives: safeguarding household incomes, revitalizing public services, and bolstering economic foundations through infrastructure investment. She has emphasized that maintaining low and stable inflation is vital for achieving her first goal.

On international currency markets, the pound weakened against both the US dollar and the euro, while UK government borrowing costs decreased in anticipation of a potential rate cut by the Bank.

Darren Jones, chief secretary to the Treasury, remarked, “The news of inflation falling below 2% will be welcomed by millions of families. However, more needs to be done to support working people, which is why our focus remains on fostering growth and restoring economic stability to fulfill our commitment to change.”

The latest figures revealed a decline in petrol and diesel prices due to lower crude oil costs, which also reduced raw material expenses for businesses. However, this was counterbalanced by an increase in food and non-alcoholic beverage prices.

Economists suggest that the drop in inflation adds to the pressure on the Bank to consider interest rate cuts, especially following data indicating a slowdown in the jobs market. A reduction in borrowing costs by a quarter of a percentage point to 4.75% is anticipated for November.

UK inflation has been on a downward trend since peaking at 11.1% in October 2022. Nevertheless, investors caution that the decline in September may be temporary, especially with Ofgem’s recent increase in the energy price cap for households.

Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, stated, “While conditions seem favorable for a November rate cut, the upcoming budget will be a critical factor as policymakers will want to evaluate the inflationary effects of any new measures before adjusting policy.”

September’s inflation rate will also be used to determine annual benefit increases, meaning many households could face losses from this lower-than-expected figure, while the Treasury stands to gain.

However, the state pension will see a substantial rise due to Labour’s commitment to the “triple lock,” which ensures increases based on the highest of inflation, wage growth, or 2.5%. With wage growth reported at 4.1%, the state pension is expected to increase by around £460 next spring.

Lalitha Try, an economist at the Resolution Foundation, noted that the timing of the inflation drop could be detrimental for many households, leading to potential losses of approximately £74 next spring compared to calculations based on August’s inflation rate.

“The government must address the disparities in benefits, which have left support for working-age individuals lagging behind rising wages and living standards,” she emphasized.

While lower inflation and borrowing costs could improve public finances if sustained, they may also signal underlying weaknesses in the UK economy, posing challenges for Labour’s central goal of fostering growth.

Reeves has warned that the £22 billion gap in public finances, which Labour claims to have inherited from the Conservatives, is likely to persist over the next five years. Reports indicate that the chancellor is considering tax increases and spending cuts totaling £40 billion in the upcoming budget to balance the budget.

Despite these challenges, she faces pressure to enhance living standards and restore public services. Paul Nowak, general secretary of the TUC, remarked, “Households are still struggling, and families need a fresh start.

“With CPI now below target and GDP growth stagnating at just 1% over the past year, this budget represents a crucial opportunity to ignite a new era of growth to help repair and rejuvenate our economy and country.”