Inflation is falling fast – but will the Bank of England move to cut interest rates?

Some economists predict rate cuts as early as next month, but don’t expect the Bank of England to abandon its caution, says James Moore

Food price inflation is finally easing, according to Wednesday’s ONS figures (EPA)

Some welcome news for consumers: inflation has once again fallen by more than expected. The headline number for February, per the Office for National Statistics (ONS), came in at 3.4 per cent – below both the consensus of the City and the Bank of England’s own forecast of 3.5.

Mercifully, given the impact on lower earners, food price rises were cited among the chief contributors to the fall. While prices continue to rise – and the cumulative effect of previous increases is still taking a terrible toll – the rate of increase declined to 5 per cent from 6.9 in the year to January. Food price inflation has now fallen for 11 consecutive months. The positive impact on the headline number was partially offset by rises in the price of motor fuel.

Food and fuel are notoriously volatile categories, and their prices aren’t terribly receptive to what the Bank of England does with interest rates. Crucially, however, “core” inflation, which excludes these (and tobacco), also took a tumble to 4.5 per cent from 5.1. It was also better than the forecasters had predicted (4.6). Core inflation has proved notably sticky, and that matters to the Bank of England’s rate-setting Monetary Policy Committee (MPC) which will welcome the decline.

The CPI “all services” rate also declined to 6.1 per cent in the year to February 2024, from 6.5 per cent in January. This is another figure to watch given the dominance of service in Britain’s economy.

In fact, taking a close look through the data, it’s hard to find much that isn’t welcome. Geopolitical events could still conspire to spoil the party. The energy price spike chiefly responsible for the sharp surge in inflation was under way before Russia embarked upon its illegal war in Ukraine, but the conflict greatly exacerbated the situation. Global flashpoints can pour red ink over any optimistic forecasts.

Pressure will mount on the Bank of England to respond to these inflation numbers by cutting interest rates early, especially if the encouraging trends continue. Those hoping for early action are likely to be disappointed by the result of the next MPC meeting, which takes place on Thursday: rates will almost certainly be held, and they will probably be held again at the following meeting in six weeks or so.

The MPC got its fingers badly burned by last year’s double-digit peak in inflation and the torrent of criticism that followed. It has also warned that, while it expects price rises to continue to ease through the first half of this year, possibly even falling below its 2 per cent target, there will be an uptick in the second half of the year. The Bank’s forecasts aren’t always terribly reliable (it is fair to ask whose are) but this should be borne in mind.

“While indicators of underlying inflationary pressures all fell on the month, they remain high, which may require the MPC to exercise caution,” was the rather downbeat assessment from the National Institute for Economic and Social Research (NIESR).

Others are much more optimistic. “We think services and overall inflation will soon fall much faster than the BoE expects. In April, we forecast CPI inflation will plunge to 1.7 per cent,” said Capital Economics, an economic research organisation.

Of the two, I tend towards NIESR’s assessment; I still think the Bank will wait until summer at the earliest before acting. But it is nice to have some optimistic numbers about the UK economy. And make no mistake, these figures are good.