News & analysis

This morning’s October CPI print saw UK inflation decelerate sharply, fractionally undershooting the market consensus and the BoE’s own forecast to kill off any notion of further BoE rate hikes.

A large fall in the headline print, which stood at 6.7% YoY in September, had been expected as a large rise in the energy price cap last year fell out of the annual calculation, as did significant base effects. Nonetheless, the 4.6% YoY price growth seen today still managed to undershoot expectations by 0.1pp, as did the core reading, with CPI now tracking below Bank of England’s November forecasts. Combined with yesterday’s wage data showing a continued softening in labour market pressures, despite a strong headline reading, and economic growth that continues to just about hold up, the latest round of data shows a UK economy that is increasingly veering towards a soft landing. Ultimately this should prove a positive for sterling, with risks increasingly skewed to the downside across a number of other developed economies, particularly in Europe where fears are growing that the ECB has overtightened. For now though, sterling traders are taking the pound lower as the residual risk of a final BoE rate hike is priced out, with the focus increasingly on the prospect of rate cuts next year. Nevertheless, we think there is ultimately a limit to how much easing can be priced in for the UK in 2024 given structural supply constraints will likely keep inflation above target for longer.

Some policy easing in 2024 will likely boost the UK’s growth outlook, however, and in combination with higher relative rates, this should dramatically improve the UK’s prospective investment outlook, and the pound over the medium-term as a result.

As we highlighted in our preview for this week’s CPI release, electricity, gas and other fuels were mechanically expected to decline in this latest CPI release, as a rise in the energy price cap to £2500 last year falls out last year falls out of the annual calculation, while the cap for this October fell to £1834 reflecting a dramatic fall in wholesale gas prices. As such, this flipped the energy sub-component from 5% YoY growth in September, to -21.6% decline in October, underpinning the massive -1.55% drag on headline price growth from housing and household services. That leaves the other volatile component of headline CPI, food and non-alcoholic beverages, the largest single contributor to rising prices once again, a position it has claimed since March. Even so, the food component also contributed a -0.24pp downwards impact on today’s CPI print, with prices continuing to ease in line with the more timely BRC shop price indicator, and in line with our pre-release call.

That said, for policymakers and markets the focus remains on measures of underlying inflation.

On this point, core inflation eased from 6.1% to 5.7%, undershooting expectations of 5.8%, with goods inflation now growing at just 2.9% YoY. Services inflation fell too, albeit from a much higher base of 6.9% to 6.6%, with a number of components continuing to post significant annual price increases. Given the wage sensitivity of these sectors, however, it is notable the divergence between restaurants and hotels and recreation and culture components of services price growth. The former grew by 7.5% YoY, but subtracted 0.13pp from overall inflation with price growth flat in October. The latter was one of two positive contributors to headline CPI, adding 0.04pp, with education adding just 0.01pp, as prices for recreation and culture rose 0.7% MoM. This correlates with PAYE data that shows both pay and employment continue to hold up better across the arts, entertainment and recreation sector when compared to accommodation and food service activities. Nevertheless, with both employment and pay pressures seemingly easing across both, albeit at different speeds, it is fair to assume that services inflation will continue to soften slowly over coming months too.

All in all, today’s release is a welcome piece of news for the BoE’s MPC members, with overall CPI growth 0.2pp below their November forecast of 4.8%.

Indeed, the UK’s 4.6% YoY price growth now places it just above France at 4.5% and a little further behind Germany with 3.0%. With price growth set to continue cooling, though admittedly at a slower pace, the focus is now likely to turn to when and how fast policy easing is forthcoming from the BoE. We continue to expect easing to begin mid-2024, with markets this morning pricing a full June rate cut, having briefly flirted with the idea last week. The slide in Bank Rate expectations is weighing on the pound in early trading, with sterling down roughly 0.15pp against both the dollar and the euro. That said, this is a muted reaction for a release that unambiguously kills off the prospect for further rate hike in our view. As we have previously suggested, a soft landing in the UK would compare favourably with conditions elsewhere, particularly with Europe., a dynamic which we see as positive for sterling. Whilst we think this is likely to take some time to fully play out, the muted reaction in FX markets this morning is indicative that others in markets may be warming to this view.



Nick Rees, FX Market Analyst


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