In a significant development for the UK economy, inflation has finally begun to ease after months of stubbornly high prices, dropping from 3.8% to 3.6% in October. This decline marks what many hope will be a turning point towards economic stability after a turbulent year.
A Welcome Decline After Months of Pressure
The latest consumer prices index shows inflation falling for the first time in five months, providing relief to shoppers, businesses and the government alike. This comes despite City economists having expected a decline last month that failed to materialise.
The current situation represents a dramatic shift from just over a year ago, when inflation had fallen as low as 1.7%, only to surge again due to rising energy bills and unexpectedly sharp increases in food prices that squeezed household budgets.
Global factors including Donald Trump's tariffs combined with domestic pressures from government tax increases in the 2024 budget to create the perfect storm that drove prices higher throughout much of 2024.
Government and Bank of England Response
Chancellor Rachel Reeves has strongly indicated that next week's budget will contain measures designed to accelerate the fall in prices, unlike last year's approach. A reduction in the 5% VAT rate on energy appears to be the leading contender, though additional measures are expected.
Reeves has also shown support for competition crackdowns in the dentistry and veterinary industries, where merger activity has raised concerns about monopoly pricing practices affecting consumers.
The Chancellor understands the political stakes clearly. Most governments caught in the inflation spiral of 2022-23 were voted out of office, and she's determined to avoid adding high inflation to the list of grievances against Labour at the next election.
Bank of England Divided on Rate Cuts
While the Bank of England's forecasts suggest inflation will reach its 2% target by 2027, the path to getting there remains contentious among policymakers. The Monetary Policy Committee (MPC) appears deeply split on how quickly interest rates should be reduced.
At the most recent MPC meeting, Governor Andrew Bailey sided with inflation hawks and used his casting vote to maintain interest rates at 4%. The nine-person panel remains divided between those who believe rates must stay elevated to hit inflation targets and others who argue reductions are possible without impacting prices due to economic slack from rising unemployment.
Financial markets remain optimistic about a December rate cut, with investors increasing the likelihood to 82% following the latest inflation figures. However, another inflation reading and updates on unemployment and wages will come before the MPC's next meeting on 18 December.
The Bank's chief economist Huw Pill maintained his concerns about high wages feeding into prices, suggesting he remains in the hawkish camp. In contrast, MPC member Swati Dhingra indicated she would vote for a rate reduction, highlighting the ongoing division within the committee.
All eyes now turn to the budget and whether Chancellor Reeves can implement measures that make the Bank of England's potential shift to rate cuts more straightforward. With meaningful reductions in the cost of living, she could provide the cover needed for Governor Bailey to switch his position from hold to cut.
