Below Target at Last: UK Inflation Falls to 1.7%, a Three-and-a-Half-Year Low Ahead of the Budget

On 16 October 2024, the Office for National Statistics (ONS) reported that consumer price inflation in the United Kingdom fell to 1.7% in September, down from 2.2% in August — the lowest reading in three and a half years and the first time headline CPI has dropped below the Bank of England’s 2% target since April 2021. The bigger-than-expected fall, driven by cheaper air fares and petrol prices, strengthened expectations of a November interest rate cut and gave Chancellor of the Exchequer Rachel Reeves a boost two weeks before her first budget, The Guardian reported.

What the September data showed

The ONS snapshot pointed to a broad slowdown in price growth, with transport-related categories doing much of the work:

• headline CPI: 1.7% year on year in September, down from 2.2% in August and a bigger fall than financial markets had anticipated;
• main drivers: lower air fares, and petrol and diesel prices that fell on the month amid weaker crude oil prices;
• business costs: the price of raw materials for companies also came down;
• offsetting factor: rising prices for food and non-alcoholic drinks partly cancelled out the declines;
• distance from the peak: inflation has been on a downward trajectory since hitting 11.1% in October 2022.

Markets reacted quickly. The pound fell against the United States dollar and the euro on international currency markets, while UK government borrowing costs declined in anticipation of the Bank of England cutting interest rates.

A November rate cut becomes the base case

Economists said the fall in inflation would add to pressure on the Bank to ease policy, after figures published on Tuesday highlighted a slowdown in the jobs market. Policymakers are expected to reduce borrowing costs by a quarter of a percentage point in November, to 4.75%.

“Though the stars are aligning for a November rate cut, the upcoming budget is the final hurdle as rate setters will want to assess the inflationary impact of any measures announced before loosening policy again,” said Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales (ICAEW).

Why the timing matters for Reeves’s budget

The reading landed two weeks before Labour’s first budget since 2010. Reeves has said the tax and spending event will focus on three key objectives — protecting household incomes, repairing public services and fixing the foundations of the economy with investment in infrastructure — and that low and stable inflation is key to the first of them.

“It will be welcome news for millions of families that inflation is below 2%. However, there is still more to do to protect working people, which is why we are focused on bringing back growth and restoring economic stability,” said Darren Jones, chief secretary to the Treasury.

The fiscal backdrop remains strained. Reeves has warned that the £22bn hole in the public finances Labour says it inherited from the Conservatives will persist over the next five years, and the BBC reported that the chancellor is looking to make tax rises and spending cuts worth £40bn at the budget to balance the books.

Who gains and who loses from a low September print

September’s inflation reading is used by the government to set the annual increase in benefits, so an unexpectedly low figure shifts money from recipients to the Treasury — though, as the Resolution Foundation thinktank noted, only temporarily:

• households on benefits stand to lose about £74 next spring compared with using the August or October readings; the Resolution Foundation forecasts inflation will return to 2.2% in October;
• the Treasury gains an estimated £500m on its welfare bill, but the saving is likely to be short-lived because the low September base will push up the following year’s reading;
• pensioners are insulated: under Labour’s “triple lock” commitment the full new state pension will rise by 4.1% — the highest of inflation, earnings growth or 2.5% — after Tuesday’s wage figures.

Paul Nowak, general secretary of the Trades Union Congress (TUC), argued households are still hurting: “With CPI now below target and GDP growth at just 1% for the last 12 months, this month’s budget is an urgently needed opportunity to unleash a new era of growth to help us repair and rebuild our economy and our country.”

The risk: inflation may not stay below target

Investors warned that September’s decline could be reversed after a rise in Ofgem’s energy price cap for households in Great Britain at the start of October. There is also a reverse risk for the public finances: although lower inflation and cheaper borrowing could benefit the Treasury if sustained, they could equally reflect underlying weakness in the UK economy, undermining Labour’s primary mission to reboot growth.