Does the drop in inflation mean things are going to get better?

As the CPI shows a fall in the overall rate at which prices are rising, Sean O’Grady looks at what it might mean for those of us hoping for an improvement in our everyday finances – and for the chancellor, too, as she prepares to announce her first Budget in two weeks’ time

Inflation has fallen once more, which, given that the country isn’t also obviously heading for recession, is good news. The Consumer Prices Index (CPI) rose by 1.7 per cent in the 12 months to September 2024, compared with 2.2 per cent in the year to August. So prices are still rising, but the latest figure is way down from the peak annual CPI rate of 11.1 per cent recorded in October 2022.

In part, the drop has been due to the diminishing impact of the invasion of Ukraine, and the Covid pandemic, on food prices and energy bills – they’re no longer doubling every year or two. But in any case, the news will be of small comfort to the chancellor, Rachel Reeves, as she approaches what might be called a “challenging” Budget...

Why is inflation down?

The effects of the pandemic and the energy crisis are wearing off, but the particular factors at the moment are actually cheaper petrol and diesel, and lower air fares, though these are offset by higher food costs. The drop in inflation isn’t quite as encouraging as it looks, though, because “core” inflation, which strips out volatile items, is not down by as much. That’s the measure the Bank of England pays most attention to.

What good will this do Reeves?

It takes some of the pressure off her, because wages are going up in real terms, and the reduction in inflation means that the Bank of England will feel more relaxed about reducing interest rates in the coming months – a help to mortgage holders and businesses at a time when market rates have been edging higher. If it is sustained, then a very gradual lowering of rates could take place over the rest of this year and through 2025.

A reduction in interest rates can certainly help a government in power to burnish its reputation – it can be taken, or spun, as vindication of its “tough” policies, and gives the impression, fairly, of economic competence and stability. In other words, it is the direct opposite of what Liz Truss and Kwasi Kwateng did with their mini-Budget two years ago.

Lower inflation and interest rates also mean that the benefits bill and the cost of servicing the national debt will ease – and the 1.7 per cent figure for September is the one used to calculate universal credit payments (though the retirement pension is protected by the triple lock, and will next year go up with wages, by over 4 per cent – £437 per annum).

So what does it mean for people on benefits?

It’s harsh. Food tends to account for a high proportion of the household budget of a person on benefits, and inflation is still relatively high there. Pensioners do rather better, as noted.

What could go wrong?

The Middle East; Taiwan; a third world war. Any major geopolitical crisis tends to panic the markets, push commodity prices (energy and food) higher, and feed inflation. Then again, in some of these scenarios, the price of the weekly shop might be the least of our worries.

What does it mean for the Budget?

Not much, in reality. Provided Reeves doesn’t freak out the Office for Budget Responsibility (OBR) and the Bank of England, and they judge that the fiscal stance is sustainable and consistent with both bearing down on inflation and a gently downward trend in rates, then she can proceed as planned. Indeed, if the rumours about a £40bn package of tax hikes and public spending cuts are to be believed, then lower interest rates and easier mortgages in 2025 are virtually guaranteed.

What are the politics of that?

While only about 40 per cent of homeowners are mortgagees, they probably represent a good proportion of the kind of working/middle-class voters that could swing between the main parties. Provided that wage growth and employment prospects remain relatively encouraging, price rises remain moderate, and mortgage bills come down, these will offset at least some of the immediate pain inflicted by the Budget. So 2025 and 2026 could be fairly encouraging years, compared to now.

Reeves might even be able to offer some selected tax cuts and targeted benefit increases (eg extending child benefit) in the run-up to the next election in 2028 or 2029. But we’re getting well ahead of ourselves.

What does the opposition say?

Jeremy Hunt, now the shadow chancellor, cheekily tweeted: “Worst economic inheritance since WWII? Of course.” It’s also fair to say that the economic policies he pursued helped to halve inflation from its peak, underpinned the Bank’s interest rate strategy, and helped get inflation back under control, albeit much of it was already going to happen for purely mathematical reasons.

But soon there’ll be a new leader of the opposition, and a new shadow chancellor, perhaps pointing to a more radical change in direction. Kemi Badenoch, for example, has hinted that she would want to demote the respective roles of the OBR and the Bank of England, and give back to the Treasury, ie the politicians, the power to set interest rates and make economic predictions. And yes, that does sound rather Truss-like...