Is the fall in the rate of inflation (CPI) for the 12 months to the end of February from 4% to 3.4% a sign of the first green shoots of recovery coming through, or is there more trouble ahead?
UK inflation has fallen to its lowest level in two and half years, boosted by a decrease in food price inflation, along with non-alcoholic drinks, restaurants and hotels.
The Office for National Statistics said inflation fell to 3.4% for the year to February, down from 4% in January, and the lowest level since September 2021.
Prices for food and non-alcoholic beverages rose by 5% in the year to February 2024, down from 7% in January. The February figure is the lowest annual rate since January 2022 and has eased for the eleventh consecutive month from a 45-year high of 19.2% in March 2023.
However, the downward effects were partially offset by a large upward effect from housing and household services.
Lindsay James, investment strategist at Quilter Investors, said: “With the majority of divisions seeing reduced levels of annual inflation in February, the data paints a picture of broad disinflation across the goods economy, with the services sector seeing a much more muted drop.”
The drop in energy bills anticipated in April could see an even greater fall in headline figures, in line with the Office for Budget Responsibility’s expectation that inflation will average out at 2.2% in 2024. However, medium-term risks in the form of energy security, supply chain resilience and structural labour shortages persist.
Experts said attention will now turn to the Bank of England’s forthcoming interest rate decision.
Wage growth has been a significant driver of inflation in the service economy for some months and recent data has shown that this is now slowing a little. However, James said this will likely make the Bank of England’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. Similarly, ongoing disruption to international shipping continues to put pressure on supply chains amidst higher freight rates and longer lead times,” said James.
“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 the Bank’s monetary policy committee will be under further pressure to consider rate cuts sooner rather than later.”
However, others believe the Bank of England will continue to hold steady, with the green shoots seen in the economic recovery likely to sustain inflation at current levels.
Tom Stevenson, investment director at Fidelity International, said: “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 that the UK economy has turned the corner.
“Attention now shifts to what the Bank of England will do with this information. 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.”
According to Derrick Dunne, CEO of YOU Asset Management: “The single largest caveat to positive progress is complacency. Past inflation crises have shown that easing the rates pedal too quickly can lead to a reinvigoration of the problem. The MPC will have this in mind as it considers a cut in the coming months.
“The expectation for borrowers, savers and investors should be that rates will stay where they are. The economy is looking weak in GDP terms, but these inflation figures, combined with relatively strong employment and wage numbers, suggest rates aren’t doing more harm than good yet.”
Daniel Austin, CEO of ASK Partners, said the likelihood that interest rates will remain untouched will result in pressure on those servicing debt.
“As property loan extensions come to an end, borrowers will be forced to inject new capital, return assets to lenders or sell in a soft market. Those assets that end up on the market will help activate the cycle and provide opportunities for buyers with capital, who will see this as the best time to acquire assets at substantial markdowns,” Austin added.
