A sharper-than-expected drop in inflation has fuelled speculation that the Bank of England could cut interest rates as early as May – but economists are warning the path ahead is far from clear.
Figures published on Wednesday showed UK inflation fell to 2.8 per cent in February, down from 3 per cent the month before and slightly below the 2.9 per cent forecast by analysts.
The surprise drop prompted City traders to raise bets on an interest rate cut at the Bank’s next meeting, with markets now pricing in a 55 per cent chance of a reduction to 4.25 per cent.
But that optimism is not universally shared.
The Bank of England’s Monetary Policy Committee (MPC) held rates at 4.5 per cent earlier this month, and despite growing calls for stimulus amid a stagnating economy, policymakers have remained cautious – especially with inflation forecast to rise again in the coming months.
That’s largely due to inflation being expected to climb once again later this year, with the Office for Budget Responsibility (OBR) predicting an average of 3.2 per cent for 2025 – and a possible peak of 3.8 per cent.
“February’s slowdown is a false dawn as notable near-term price rises are already baked in, with next month’s jump in energy bills and national insurance likely to push inflation perilously close to 4 per cent sooner rather than later,” said Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales.
Others are more measured.
Laith Khalaf, head of investment analysis at AJ Bell, told The Independent: “Markets are pricing in two rate cuts this year but there is clearly some uncertainty around that and the precise timing of rate cuts is difficult to predict.
“On the one hand the economy could do with stimulus, but on the other inflation is rising. Seeing as the OBR and Bank of England expect inflation to peak at around 3.8 per cent in the third quarter, the Bank may decide to get a rate cut in before the inflation numbers start to climb too high.”
The OBR now expects the base interest rate to fall to 3.8 per cent next year, having previously forecast a drop to 3.5 per cent.
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Yet several economists argue that February’s figures won’t significantly change the Bank’s outlook.
Thomas Pugh, economist at RSM UK, said: “While a drop in headline inflation is good news for the Bank of England, it’s unlikely to make much difference to the outlook for interest rates for two reasons.
“Firstly, services inflation, which is more reflective of price pressures in the domestic economy, was flat at 5.0 per cent.
“Secondly, the MPC will be much more concerned about how inflation is looking after April, when the tax rises contained in the budget will take effect, than how inflation was back in February.
“Our base case is still for a rate cut at every other meeting this year, but the risks are clearly growing that the MPC stops its easing cycle early and rates don’t go below 4 per cent.”
The impact on households remains mixed. While the drop in inflation may hint at relief for some, it’s unlikely to deliver the rate-cut-led boost many are hoping for.
Alice Haine, personal finance analyst at Bestinvest, said: “Mortgaged homeowners and first-time buyers may take some comfort from the latest inflation reading, but with the headline rate expected to tick upwards in the coming months it may not deliver the change they ultimately want – a fourth interest rate cut.
“The next rate decision from the MPC won’t happen until May and Britain’s worsening inflation outlook coincides with a time when the economy is also stagnating. It means UK interest rates may stay higher for longer – not something prospective buyers or mortgaged homeowners about to refinance will want to hear.”
On the broader outlook, Rachel Winter, partner at wealth and investment management firm Killik & Co, added: “The pound has remained reasonably stable, but it may be impacted by future inflation movements.
“If inflation does indeed average 3.2 per cent for 2025 as predicted, it will be difficult for the Bank of England to continue cutting interest rates. This could strengthen the pound, although it would likely put the brakes on economic growth.”