Fall in inflation to 6.7% leaves interest rate decision in balance

A senior Bank of England policymaker has warned the central bank could be forced to keep raising interest rates to prevent high levels of inflation from becoming entrenched in the economy.

The Bank of England’s decision on whether to push ahead with another interest rate rise today or hit pause was on a knife-edge after a cooldown in inflation in August surprised the City.

Expectation that the monetary policy committee (MPC) would impose another 25 basis-point rise, lifting the base rate to a 15-year high of 5.5 per cent, fell from a near-certainty to odds of 50-50 within minutes of yesterday’s unexpected data from the Office for National Statistics (ONS).

Goldman Sachs, Deutsche Bank and Nomura all changed their calls to predict a hold at 5.25 per cent. The yield on two-year UK government bonds fell to a three-month low of 4.83 per cent and sterling weakened against the dollar, before stabilising at $1.24.

The shift in sentiment came after ONS data suggested that annual inflation slipped to 6.7 per cent in August, down from July’s 6.8 per cent. Analysts and the Bank of England’s forecasters had forecast a rise to about 7 per cent.

Measures of underlying inflation also fell sharply. Core inflation, which strips out volatile food and energy prices and is monitored closely by the MPC, dropped to 6.2 per cent from 6.9 per cent, way below Bank projections.

Today’s interest rate decision had been billed as the toughest to call since December 2021, when the Bank embarked on the most aggressive run of rate rises in more than three decades.

Data since the MPC’s last meeting in August has been mixed. Growth has reversed while unemployment has accelerated faster than predicted, suggesting that aggressive tightening is feeding through into the real economy.

On the flip side, private sector wages, which indicate that inflation is becoming embedded into the economy, rose by more than 8 per cent in the three months to July. Consumer price inflation is still running well in excess of three times the Bank’s 2 per cent target.

Goldman’s team said: “Combined with their recent dovish commentary, we now expect the MPC to keep the Bank rate unchanged.”