UK inflation set to jump above target in headache for Rachel Reeves

UK inflation is expected to have jumped above the Bank of England’s two per cent target in October, bolstering a cautious approach to cutting interest rates in the months ahead.

A more gradual easing of monetary policy would be a headache for the new government, which has tried to reassure markets that last month’s big-spend Budget will boost economic growth without leading to runaway inflation.

Economists forecast the consumer price index (CPI), due on Wednesday, to come in at 2.2 per cent for last month, up from 1.7 per cent in September.

Higher energy prices are expected to drive the increase, with regulator Ofgem hiking its price cap on household bills by 9.5 per cent last month.

A better, albeit still elevated, number is expected for underlying gauges like services inflation, which rate-setters pay close attention to.

The BoE forecasts services inflation to tick up to five per cent in October, from 4.9 per cent in September. Analysts at Deutsche Bank expect a slight slowdown to 4.8 per cent.

A larger-than-expected rise could give policymakers further cause to leave rates on hold in December, after already making two cuts this year.

BoE governor Andrew Bailey has warned that services inflation “is easing only gradually” and that a “more substantial fall” is unlikely this year.

His comments underscore the BoE’s gradual approach towards cutting interest rates. Markets expect policymakers to hold rates next month before making a quarter-point cut in February.

Bailey has also suggested policymakers are still waiting to judge the impact measures in Chancellor Rachel Reeves’ first Budget will have on the UK economy.

The BoE raised its inflation forecasts for the next three years after Reeves increased taxes on employers, which business groups have warned could lead to higher prices and a hiring slowdown.

“The headaches in a sense are of her own making, given that despite two rate cuts, yields and interest rate cut expectations have moved against her due to anxiety over her Budget measures,” Michael Hewson, an analyst at Market Insights, told City AM.

“Along with an expectation that headline CPI is likely to edge back above two per cent in the months ahead and sticky core and services inflation, it means that markets have little confidence that the Bank of England will be able to cut rates significantly before the middle of next year.”

Sanjay Raja, chief UK economist at Deutsche Bank, said the headline rate of inflation would likely “pick up from here”.

“Indeed, it’s likely that inflation has troughed with upward pressure likely to keep CPI above two per cent over the next year or so,” he added.

“Administrative tax changes as per the Autumn Budget have raised our forecasts by nearly 10 basis points in 2025. And there’s some upside brewing given the indirect effects of the large fiscal package.”

Deutsche Bank said last week that Reeves’ hike to employers’ national insurance could end up costing the UK economy more than 100,000 jobs.

Bailey is due to appear before MPs on the Treasury Committee on Tuesday, where lawmakers are expected to question him about the Budget’s economic impact, as well as official data on Friday which showed GDP grew at a slower pace than expected in the third quarter.

He will be joined by fellow rate-setter Alan Taylor in his first public appearance since joining the monetary policy committee in September.