Inflation in the UK will soon fall. But how far and for how long? | inflation

Jeremy Hunt knows it. Rachel Reeves knows it too. The Office for National Statistics is expected to deliver some good news on Wednesday when it releases its latest inflation figures. The only real question is how good the news is.

As of March, the annual inflation rate measured by the consumer price index reached 3.2%. April's figures will be much lower and, if Hunt is lucky, could even go as low as the government's target of 2%.

The sharp decline is mainly due to movements in electricity and gas prices. Domestic energy bills rose in April 2023 but have fallen by 12% for most households this year. The energy price ceiling was set from 2,500 won last year to 1,690 won last month.

In other words, the base effect means that it is inevitable that the inflation rate will fall due to the lower cost of heating, cooling and lighting this year compared to the situation a year ago.

Hunt is a savvy enough politician to avoid claiming outright victory when the numbers come in. The Prime Minister knows his voters have seen prices rise by 20% in less than three years and may not accept that the cost of living crisis is over.

And this never ends the game. The Bank of England expects annual inflation to rise again to around 2.5% in the second half of 2024, when the Prime Minister is likely to call a general election later this year.

But despite further warnings that prices are not actually falling, but only rising at a slower pace, it is far more comfortable than Hunt's position was when he was appointed Prime Minister, succeeding Kwasi Kwarteng, by Liz Truss in October 2022. Inflation that month reached 11.1%, the highest level in 40 years.

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The focus is on the inflation generated by the domestic economy rather than headline interest rates, which are influenced by international prices.

Double-digit inflation brought back unhappy memories of the mid-1970s. At the time, inflation soared to more than 25%, a post-war high, eventually necessitating a bailout from the International Monetary Fund (IMF).

Coincidentally, the IMF team has been conducting its annual health check on the economy in the UK over the past two weeks. Unlike in 1976, the Fund will not call for unpopular spending cuts and the outcome of the so-called Article IV consultation will help Hunt as he realizes Britain is experiencing its worst cost-of-living crisis. But if the study concludes that additional tax cuts before the election will be followed by tax increases or new austerity measures after the election, it could involve a sting in the tail.

But in the near term, the focus will be on what lower inflation means for interest rates. Threadneedle Street said the official borrowing costs were raised by the Monetary Policy Committee on 14 occasions between December 2021 and August 2023, after which interest rates were left unchanged. That's because the majority of MPC members want to make sure inflation is actually overcome.

The focus is on the inflation generated by the domestic economy, not on inflation rates that are influenced by global prices of energy and food. Instead, the MPC is currently observing services sector inflation at 6%. The headline inflation numbers will be good on Wednesday, but it will be the fine print that really matters.

Susannah Streeter, head of currencies and markets at Hargreaves Lansdown, said: Hopes of a rate cut in June will be higher if inflation reaches its sweet spot. But even if you reach the coveted 2% target, it would be wise not to raise flags and splash celebratory cash.

Bank of England policymakers have stressed that they need confidence that inflation will continue to stay at or near target levels before reducing borrowing costs.

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