Why the Bank of England will hold interest rates tomorrow

Gone, it seems, are the days when monthly inflation figures blew past expectations, sparking a lot of panic and a little glee in trading floors around the Square Mile.

The latest figures out this morning were a more sedate affair. The headline rate remained at 2.2 per cent, exactly in line with expectations.

On the face of it there were a few more concerning signs under the hood, but nothing to really set the cat among the MPC members.

Core inflation and services inflation, which reflect underlying price pressures better than the headline measure, both rose a little in August, but the increase was largely as expected.

Services inflation – which has become one of the main concerns for rate-setters over the past few months – actually came in slightly below the Bank of England’s November forecasts.

It rose to 5.6 per cent in August, up from 5.2 per cent the month before. This was largely due to so-called ‘base effects,’ which reflects the impact of last year’s figures on the annual comparison.

Some of the other strength in services inflation could be attributed to changes in erratic areas.

Air fares, for example, rose by 22 per cent month-on-month, the second highest increase on record.

The MPC’s measures of underlying services inflation often exclude these more volatile components.

The Bank of England to make announcement

Reflecting these considerations, Matt Swannell, chief economic advisor to the EY Item Club, said the uptick in services inflation should “prove temporary”.

Food and energy inflation also surprised to the downside, adding to the impression that inflation is more or less under control.

That’s not to say the Bank will cut rates tomorrow. Services inflation is still running too hot to be absolutely sure that the overall index will return to the two per cent target.

Ruth Gregory, deputy chief UK economist at Capital Economics, said: “There’s no denying that services inflation is still too high for the Bank of England’s liking.”

Regular pay growth also remains over five per cent while unemployment has fallen back to 4.2 per cent, suggesting the labour market remains tight.

The firm consensus, therefore, is for the Bank of England to hold rates tomorrow.

But economists expect to see continued moderation in all of these measures over the remainder of the year, which will likely pave the way for at least one further interest rate cut.

Sanjay Raja, chief UK economist at Deutsche Bank, said the MPC would likely view the figures as a “positive sign that underlying price pressures are easing”.

A rate cut in November looks likely at this stage, but the path beyond that is uncertain. It is worth noting that one of the reasons why inflationary pressures are expected to continue easing is that interest rates will remain relatively high, so don’t expect the Bank to rapidly cut rates.

Nevertheless, it looks increasingly clear that rates can continue to be cut without sparking a resurgence in inflation.