Inflation surprise scuppers hope of Christmas interest rate cut

A bigger than expected rise in inflation last month has all but scuppered hopes of a cut to interest rates by the Bank of England in December.

While economists had been expecting rising energy prices to push inflation beyond the Bank of England’s two per cent target last month, a sharper than expected lift in services and core inflation, which strips out volatile food and fuel costs, may be a headache for rate-setters.

Core inflation rose from 3.2 per cent to 3.3 per cent – above a consensus forecast for a fall to 3.1 per cent – while services inflation rose from 4.9 per cent to five per cent.

The surprise will pile pressure on the Bank of England to take a more steady approach to cutting interest rates as the UK faces the potential return of sharper inflation in the wake of Rachel Reeves’s big spending Budget in October.

According to its most recent forecasts, the Bank of England expects Reeves’s fiscal plans, in which she revealed plans for £30bn extra spending per year, to add almost half a percentage point to inflation at its peak in just over two years’ time.

The Bank has repeatedly warned it will take a “gradual” approach to interest rate cuts over the next year and the latest inflation surprise.

“A gradual approach to removing monetary policy restraint will help us to observe how this plays out, along with other risks to the inflation outlook,” Bank governor Andrew Bailey told MPs yesterday.

Traders have now reined in their bets on fast interest rate cuts, with markets now pricing in a ten per cent chance of a Christmas cut and as few as three cuts next year.

 “While we think the Bank of England will continue to cut rates in 2025, the pace of rate cuts is expected to be slower than previously anticipated, and rates may stay elevated for longer,” NIESR associate economist Monica George Michail said today.

Luke Bartholomew, deputy chief economist at Abrdn, warned that headline inflation is likely to “drift further above target for the next few month” but the “fundamental determinants of inflation that will determine the path of interest rates from here”. 

“With the Budget set to boost growth and inflation next year, there is little reason for the Bank to deviate from its only gradual rate cutting schedule any time soon,” he added. “So we continue to expect the next rate cut early next year.”  

After raising interest rates from 0.1 per cent to 5.25 per cent in 14 consecutive jumps from December 2021 to August 2023, the Bank cut rates by 0.25 per cent in August and lowered them by the same amount to 4.75 per cent earlier this month.