The British pound fell 0.6% against the US dollar, reaching $1.30 on Wednesday after UK inflation came in lower than anticipated.
The Office for National Statistics (ONS) reported that inflation dropped to 1.7% in September, its lowest level in three years.
This decline was greater than market expectations, which had forecast a rate of 1.9%. Falling airfares and petrol prices were significant drivers behind the slowdown in inflation.
The pound’s weakness followed the release of the data, with traders reassessing their expectations for further interest rate cuts by the Bank of England (BoE). Before the report, market predictions put the likelihood of two quarter-point rate cuts by the end of 2024 at about 50%. Following the release, these odds rose to 75%.
Expectations of Further Interest Rate Cuts
The unexpected drop in inflation has intensified speculation that the BoE will cut interest rates at its November meeting, with many investors now also anticipating an additional cut in December. Paul Dales, chief UK economist at Capital Economics, commented, “The chances of a quarter-point cut in December have just gone up following today’s release.”
Market strategists believe that the inflation figures give the central bank room to act more aggressively. The BoE already cut rates by a quarter-point in August and is widely expected to take further action as inflation continues to ease.
Inflation Below BoE Target
September’s inflation figures bring the annual rate below the BoE’s 2% target for the first time since April 2021. Core inflation, which strips out volatile components like energy and food, also fell to 3.2%, below economists’ forecasts. The retreat in inflation strengthens the argument for rate cuts aimed at stimulating economic growth.
Market Response and Bond Yields
Along with the drop in the pound, UK bond yields also fell. The yield on two-year government bonds, which are sensitive to interest rate movements, dropped by 0.09 percentage points to 4.04%. Lower inflation and cooling wage growth have contributed to this decline, with the latest data showing UK wage growth falling to 4.9% from 5.1% in the previous period.
Implications for the Bank of England
Bank of England Governor Andrew Bailey recently hinted that policymakers could adopt a more aggressive stance on reducing borrowing costs if inflation trends downward. This latest data reinforces those expectations. Many analysts now predict that the BoE will lower rates not just in November but again in December.
Despite this, some economists caution that inflation could rise again towards the end of the year. ING’s James Smith noted that headline inflation could bounce back to 2.5% as the impact of falling energy prices fades. However, he believes that the BoE is positioned to accelerate rate cuts if necessary.
What do you need to know?
The pound’s decline reflects growing market anticipation of further interest rate cuts by the BoE as inflation falls below target.
While the pound faces short-term pressure, the central bank’s actions in the coming months will be critical in determining its longer-term trajectory.
Investors are now closely watching both the BoE’s upcoming decisions and the UK government’s fiscal policies as outlined in the forthcoming Budget.
