The Bank of England will draw little comfort from this morning's Consumer Prices Index (CPI) release. Headline inflation remained stuck at 2.2% for August, defying expectations of a modest dip. The core measure, stripping out volatile food and energy, actually ticked up to 3.6% from 3.4%. For those of us who have watched the Bank’s monetary policy committee contort itself over the past 18 months, this is a sobering reminder that the battle against rising prices is far from over.
Yet beneath the surface, there are glimmers of something approaching good news. Food price inflation has eased to its lowest level since October 2021, falling to 8.2% from a peak of 19.1% last year. That is still painfully high for households, but the direction of travel is finally benign. Supermarket price wars and falling wholesale costs are beginning to feed through to the checkout. The question is whether this is a temporary reprieve or the start of a sustained decline.
Services inflation, the Bank’s favoured gauge of domestic price pressures, remained elevated at 5.5%. This is a reminder that the labour market is still too tight for comfort. Wage growth, though slowing, is still running at around 6% — well above the level consistent with the 2% target. The Bank’s own forecasts suggest services inflation will stay above 5% until at least the spring of 2025.
The market reaction was predictable. Gilt yields rose marginally, with the 10-year benchmark pushing back above 4.2%. Sterling strengthened against the dollar and the euro, reflecting market expectations that interest rates will stay higher for longer. The implied probability of a rate cut at the next MPC meeting has fallen to just 15%.
The Chancellor will be relieved that inflation has not risen, but he cannot afford to be complacent. The fiscal arithmetic remains punishing. With index-linked gilts accounting for around a quarter of the UK’s debt stock, every basis point of higher yields adds billions to the debt servicing bill. The Office for Budget Responsibility’s next forecast, due in November, will almost certainly show that the headroom against the fiscal rules has evaporated.
What does this mean for investors? The carry trade is no longer a one-way bet. Sterling’s strength is a double-edged sword: it suppresses import costs but also hurts export competitiveness. The FTSE 250, which is more domestically orientated than its large-cap cousin, has underperformed the S&P 500 by nearly 10% this year. Capital flight remains a concern, as global investors seek yield elsewhere.
For the average household, the news is mixed. Falling food prices are welcome, but the cost of housing, transport, and utilities remains elevated. The average mortgage rate for a two-year fix is still above 6%, and thousands of households rolling off fixed-rate deals this autumn face a payment shock of hundreds of pounds per month.
The Bank of England finds itself in a bind. Cutting rates too soon would risk embedding inflation expectations above target. Waiting too long would crush economic activity. The MPC’s hawks will point to the stickiness of services inflation as a reason to hold fire. The doves will argue that the lagged effects of previous rate hikes have yet to fully feed through.
My own view, for what it is worth, is that the risks are skewed towards higher-for-longer. The labour market is still too tight, and the government’s fiscal stance is not as tight as it should be. The Chancellor’s decision to uprate benefits by September’s inflation figure, rather than the lower February figure, adds around £2 billion to public spending next year. That is a stimulus the economy does not need.
In summary, today’s inflation data is a reality check. The crisis is over, but the hangover will persist. Investors should brace for continued volatility, and households should not expect any near-term relief on borrowing costs. The era of cheap money is well and truly behind us.
