The ONS has this morning reported the latest UK inflation data showing that UK CPI has fallen more sharply than expected to 3.4% in the year to the end of February – down from 4% last month. This means UK inflation is at its lowest level for over 2 years.
With the Bank of England’s MPC poised to make their next rate decision tomorrow, the data make for interesting reading and will have consequences for the next move in interest rates – whenever that might be.
But what do market watchers and investment strategists make of this latest positive inflation data and when we might start to see cuts to interest rates?
Lindsay James, investment strategist at Quilter Investors said:
“UK inflation has fallen to the lowest level seen since September 2021, with the annual rate coming in at 3.4% in February having been stuck at 4% for the prior two months. Meanwhile, core inflation also dropped to 4.5% down from 5.1% in January.
“With the majority of divisions seeing reduced levels of annual inflation in February, with areas such as food and communication seeing notable falls, the data paints a picture of broad disinflation across the goods economy, with the services sector seeing a much more muted drop. The plunge in energy bills anticipated in April could see an even greater fall in headline figures, aligning with the Office for Budget Responsibility’s expectation that inflation will average out at 2.2% in 2024. However, economist forecasts for the medium term have considerable variance, highlighting risks that are still present around energy security, supply chain resilience and structural labour shortages.
“Wage growth has been a significant driver of inflation in the service economy for some months, and recent data showed this is now slowing a little. However, it will likely make the Bank’s 2% target more difficult to achieve. This looks likely to remain a strong inflationary driver while there is an ongoing mismatch in the labour supply available and the level of demand on offer, with recent business surveys flagging that this pressure remains elevated and a cost they are passing through to customers in the form of price rises. Similarly, ongoing disruption to international shipping continues to put pressure on supply chains amidst higher freight rates and longer lead times.
“With signs that the UK has already returned to a modest level of growth despite interest rates remaining high, this inflation reading will give confidence to the Bank of England that inflation is now coming to heel. As it looks likely to fall further in coming months, with the 12% cut to the energy price cap kicking in from April, the Bank’s monetary policy committee will be under further pressure to consider rates cuts sooner rather than later.”
Tom Stevenson, Investment Director at Fidelity International, comments:
‘The significant – and slightly bigger than forecast – fall in inflation from 4% to 3.4% in February was expected and welcome. It provides a helpful backdrop to tomorrow’s rate-setting decision by the Bank of England.
‘Inflation is likely to continue dropping through the spring as cheaper gas and electricity from April drives household energy costs lower. The key unanswered question is whether, and by how much, price growth bounces back from target in the second half of the year – the Bank’s central expectation.
‘Cheaper food was the biggest downward contributor to the February inflation rate, while housing costs and fuel provided some upward pressure.
‘The UK has been an outlier, as inflation has fallen back more slowly than our peers. But the latest data shows us falling back in line with the US and Europe. It provides substance to the government’s claim, at the Budget and elsewhere, that the UK economy has turned the corner.
‘Attention now shifts to what the Bank of England will do with this updated information this week. The expectation remains that interest rates will stay on hold until June at least, and will fall back only slowly from the current 5.25%. Inflation may briefly touch the Bank’s target in the next few months but is not expected to settle at 2% until 2026.
‘That means homeowners expecting a significant easing in mortgage rates this year face higher for longer borrowing costs. This will keep a lid on the nascent housing recovery that has seen prices stabilise in the past few months.
‘The UK stock market meanwhile, has lagged its rivals recently, and now looks good value as the economic and political backdrop improves.’
CPI will ‘start with 1%’ as soon as April according to James Lynch, fixed income investment manager at Aegon Asset Management as he comments:
‘Another large drop in the headline inflation rates in the UK this morning. CPI fell from 4.0% in January to 3.4% in February. According to the ONS data the largest downward contributions came from food, restaurants, and cafes – that is logical given the previous huge prices rises we have seen in the past in these categories could not be maintained. Food inflation peaked in the UK at 19.2% in March 2023 and has now dropped to 5%, and with further indications this fall is expected to continue which will have a knock on effect in different categories of the inflation basket.
‘Looking forward over the next few months we still expect to see CPI inflation in the UK to start with a 1% as soon as the April print. In large part to the fall in food and indeed the OFGEM energy price cap change.
‘We have the MPC meeting of the BoE tomorrow (21st March) where once again rates are expected to remain on hold at 5.25%. Last month two members voted for a hike in interest rates, one for a cut and six for unchanged rates. Given the sluggish economy, looser labour market, and high confidence that inflation will be below target in the coming months, it is a struggle to see why two members believe interest rates still need to move higher. So if there is a change tomorrow this is where I would expect it to come with a change in the voting pattern.’
Rachel Winter, Partner at Killik & Co said: “Today’s fall in inflation will be hailed as good news, further signalling the steadying of prices. The lower inflation reading will likely bring confidence to investors, indicating another step towards economic stability after two years of turbulence. Companies and individuals will be able to plan for the year ahead with greater certainty.
“The inflation situation has improved significantly since October 2022 when it hit 11.1%. Furthermore, last week’s GDP data showed that the UK economy emerged from recession and returned to growth in January, expanding 0.2% thanks to an improvement in retail sales. Although it is not expected that the Bank of England will cut rates when it meets tomorrow, the fall in inflation should encourage it to start doing so later this year, which should be good news for stocks, bonds, and property.””
Zara Nokes, Global Market Analyst at J.P. Morgan Asset Management (JPMAM) said:
“Following a torrid couple of years for UK households, this morning’s inflation print is yet further evidence that the outlook for consumers is brightening. While the Bank of England will also cheer the decline in the headline figure, it is unlikely to be convinced that the battle against inflation is won. More good news should be on the way with headline inflation likely to drop below the 2% inflation target in the Spring, but crucially, this is largely being driven by a transitory fall in energy prices. The Bank will instead be keeping a watchful eye on the medium-term inflation outlook, particularly the domestically-generated inflation originating from the services sector. With regular wage growth north of 6% and services inflation still running hot, the Bank will need further evidence that domestic price pressures are cooling before it begins cutting rates.”
UK inflation bumps down, with relief for daily shop says HL’s Susannah Streeter as she comments:
“With UK headline inflation taking a bigger bump down than expected on its uneven path, it’ll provide fresh relief for consumers and companies who face the unenviable task of finding new finance in an era of high borrowing costs. Lower price rises for food and non-alcoholic drinks accounted for a big chunk of the decline, coming in at 5% in the year to February compared to 7% in January. It will bring a big dose of comfort to shoppers given the super-painful food inflation rates they were having to deal with last March when they shot up to 19.2%, the highest rates for 45 years. While the daily shop is now not quite so scary, shoppers are still having to deal with a new reality of higher prices than they were used to in the past.
“Core inflation, when you strip out volatile food and fuel prices, also fell back from 5.1% to 4.5%. With the prices heading in the right direction, and not proving any more stubborn than the Bank of England predicted, the pound has not moved much, rising a little before declining and trading around $1.271. The fall in inflation is not going to mean any sharp moves from Bank of England policymakers, who are set to stay in their wait and see stance. They are likely to still want more evidence that wage growth, which is still elevated, will ramp down further before they budge and bring in a rate cut, despite the fears that it will dampen any hopes of igniting growth in the economy.
Although the Office of Budget Responsibility, the government’s independent forecaster, reckons inflation will hit the Bank’s 2% target this quarter, especially with the lower energy price cap taking effect in April, there are risks that it’ll be a short-lived dip and overall prices will take off again.
“Potentially inflationary pressures ahead include the ongoing fight for talent, higher shipping costs due to Red Sea disruption, and the increase in the minimum wage, and business rates. Increasing consumer and company optimism could see spending ramp up, especially with the cuts to NI putting more money in pockets and potentially putting upwards pressure on prices. Of course, there’s a chance that consumers will stay more prudent, and pay off loans instead of splashing the cash, while others may use more generous savings rates on offer to wisely squirrel away an emergency fund. Given the uncertainty ahead, the name of the game will still be caution in the months ahead. Expectations had edged towards a cut in August, when the Bank also publishes the summer monetary policy report an in-depth view on economic conditions, but bets are likely to mount again on a first cut coming in June.”
Boudewijn Driedonks, Partner at McKinsey & Company said:
“The Bank of England’s inflation target of 2% is finally in sight. The drop to 3.4% in consumer inflation sees price increases reach their lowest levels in two and a half years, and is the first decisive fall since inflation started flatlining in November.
“The biggest downward pressures are coming from food & non-alcoholic beverages, and restaurants and hotels. The wild price surges of the last four years are softening. For example, bread has come down from over 20% inflation a year ago to 1% today while the sea corridor for Ukrainian exports remains open. And milk, cheese and eggs have shifted from highs of over 30% a year ago to 0.4% today.
“The decline in manufacturing prices that we started to observe earlier this year is trickling through into consumer prices today. While factory gate output prices rose by 0.4%, input prices of manufactured goods have come down 2.7% year-on-year. But overall, we see manufacturing factory prices stabilising.
“We are now approaching an important tipping point. Inflation is tapering off and we see some hopeful signs that growth may be returning. We may be touching down in the soft landing that many were hoping for. But, it also remains hard to plan on any forecast. We have seen alternating increases and decreases in manufacturing input and output prices making it tricky for manufacturers to uphold stable margins.
“So businesses will need to double-down on holistic revenue management and use all the levers at their disposal – pricing, promotion, discounting, and product mix management – to find the right balance between protecting margins and capturing pockets of growth.”
Commenting on UK CPI, Marc Cogliatti, Head of Capital Markets, EMEA at Validus Risk Management, said: “Headline UK CPI fell to 3.4% y/y in February, slightly lower than the 3.5% economists were expecting. Most notably, it was also below the Bank of England’s own forecasts implying there may be a little more scope for the Monetary Policy Committee to ease than previously thought. This message was reinforced by a dip in the core reading which fell from 5.1% in January to 4.6% in February.
Unsurprisingly, sterling is a touch lower on the news with markets now pricing in an additional 4bps of cuts this year. From a big picture perspective, since the start of this year, the market has already paired back expectations of six 25bps cuts to three in 2024 amid the tight labour market, stubbornness of the core reading and ongoing price pressures in the service sector. Therefore, this morning’s news is certainly welcome and confirmation that UK consumers should start to see the pressure ease in the months ahead.”
Commenting on the print and looking ahead to tomorrow’s BoE decision, Isabel Albarran, Investment Officer at Close Brothers Asset Management, comments:
“Whilst today’s greater than expected fall in inflation to 3.4% will no doubt be welcomed by central bankers and consumers alike, it is unlikely to bring about an immediate change in the BoE’s rate cut stance, and we expect them to continue to hold firm at 5.25% at tomorrow’s meeting.
“That said, the story in the UK is definitely more straightforward than in the US, and these figures, coupled with recent easing seen in the UK labour market print and the further decline in CPI expected to arrive with April’s Ofgem price cap, are certainly a sign of better things to come. While the BoE only relatively recently dropped their explicit tightening bias in the February meeting, we anticipate rate cut discussions to become live in May when we will see a new monetary policy report and updated forecasts. These forecasts will incorporate today’s soft CPI as well as more rational rate cut predictions, making it increasingly likely that they will project CPI at or below the 2% target at the end of the forecast period. If this is the case, it will become almost impossible to make the case against rate cuts.”
