Following a bad inflation print for the UK in November, which fell by -0.2% m/m. That drop, along with some easing from other pandemic-influenced inflation categories, has helped bring down the annual inflation rate. It dropped, for example, from 3.6% to 3.2% in October. Core inflation, which strips out volatile items like food and energy, was similarly flat at 3.2%. Amid all of these developments, expectations for a future cut from the Bank of England (BoE) have taken root.
July’s inflation numbers reflect that progress—even on the gas prices front. Nonetheless, the UK is still far above its target rate of 2%. That moderation in inflation is a pretty positive indicator. It does raise alarms over the risk of persistent structural inflation problems keeping us from ever getting there.
Inflation Trends and Market Reactions
Today’s inflation print lays bare the uncertain forces at play in our economy and what that means for how government should act. Service price inflation fell marginally, moderating to 4.4% from 4.5%. It indicates a continued easing in price pressures in the important services sector, key to containing inflation and assuring stable economic growth. Despite these overall positive signs, the UK’s inflation is still well over the target of 2%.
The price of both the stock and bond markets has already responded very decisively to the clear moderation in inflation. The BoE as of now has a 97% chance of making a rate cut. In response, sovereign bonds known as Gilts are rallying and the pound is under selling pressure. The latest inflation figures have been significantly responsible for driving the pound lower. Markets are still readjusting themselves as investors look to set expectations for what the central bank will do next.
Our detailed analysis suggests that positive UK inflation news may be on the horizon, at least in the short term. Economic analysts predict a sharp reduction in price pressures over the coming months as negative base effects from the first half of 2025 drop out of the index. We welcome this transition as an opportunity to create better market conditions for consumers and businesses to thrive together.
Structural Challenges Ahead
Both the monthly and annual inflation rates are moving in the right direction. Structural challenges will make it increasingly difficult to meet the 2% target going forward. Indeed, some analysts caution that the underlying inflation issues could continue to resurface and derail any durable moves in the direction of long-term price stability.
Despite seeming like a wonky technocratic body, the BoE’s Monetary Policy Committee (MPC) is struggling with basic fundamentals fits in how to respond to these extreme economic conditions. This unusual vote split may help shape market reactions in the weeks and months ahead. As policymakers look to plot their next moves, that task will require weighing the desire for near-term rate cuts with the risks posed by structural inflation pressures.
Alongside inflation rates dropping across the UK, UK bond yields have dropped. The UK’s two-year yield is down 4 bps. At the same time, the ten-year yield is down 4.3 bps on net. The culprit for this drop is investor confidence in a potential rate cut. First, it indicates a change in market sentiment regarding the expected path of monetary policy.
Future Implications for Monetary Policy
When considering these recent developments around UK inflation, hopes for a rate cut are coalescing amongst economists and financial markets. How the BoE responds and what they focus on in their response will be key in developing the short-term and long-term economic conditions. While a rate cut would deliver immediate relief to borrowers, such a move would likely heighten concerns over the Fed’s longer-term inflation stability.
As the BoE deliberates its next steps to pursue a more sustainable outcome, it should be mindful of the systemic economic context. Although cooling inflation rates are welcome news, underlying structural problems may make it hard to keep inflation in check in the long run. Policymakers will need to be ever-vigilant as they meet these opportunities and challenges. They need to recognize that they can’t make decisions that add to the current inflation pressures.