The rate of inflation had a sharp drop to 4.6% in the year to October from September’s 6.7%. This rate is lower than the predicted 4.8% and inflation is now at its lowest rate since 2021. The government had pledged to halve inflation by the end of 2023 and has now reached that goal early. So what caused the sudden drop and what does it mean for interest rates as inflation slows?
Why has there been a sharp drop in inflation?
The drop to the current inflation rate of 4.6% – a significant decrease since its 41-year high of 11.1% in October 2022 – is predominantly credited to the lower energy price cap, as confirmed by the Office for National Statistics (ONS). The cap limits the amount that households are charged per unit of energy. Official figures have also shown that increasing food costs slowed further in October and hotel prices have come down.
Inflation had already started to decrease as a result of the continuous base rate increases. This was the main strategy used to combat inflation, encouraging saving over borrowing. In November, a decision was made by the Monetary Policy Committee (MPC) to keep the base rate at 5.25%, the same as the previous 2 months. There were positive signs of inflation decreasing. As well as that, pushing the base rate higher again may well have pushed the UK economy into a recession. Economists have predicted that the base rate will continue to stay at that level for a while until the economy has stabilised.
As inflations slows, what does this mean for interest rates?
With the rate of rising food costs slowing down, a lowering of the energy price cap and other positive signs as inflation slows, it may be expected that the cost of living would begin to ease. However, the decreasing inflation rate means that the prices of goods and services aren’t increasing as quickly as before. It doesn’t, unfortunately, mean that the prices have become cheaper. Food and energy prices, for example, are still higher than they were 2 years ago, according to the ONS.
With so many people struggling to cope with the cost of living at the moment, especially with high mortgage or rental payments to make, inflation still needs to come down to the Bank of England’s target of 2%. As such, interest rates are expected to be held at the current level for the long term. Interest rate reductions are unlikely until both the labour market and price growth have stabilised. It has been predicted, therefore, that the first interest rate cut won’t be until mid-2024.
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