Pound falls as UK inflation falls sharper than expected to 1.7%

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Inflation in Britain fell more than expected, hitting a three-year low of 1.7% in September, sending the pound lower and prompting traders to increase bets on further interest rate cuts by the Bank of England this year.

Data released by the Office for National Statistics on Wednesday showed inflation has returned below the BoE's 2% target for the first time since April 2021.

The annual rise in consumer prices was lower than the 1.9% forecast in a Reuters survey of economists and compared with the August figure of 2.2%. This retreat has been driven by declines in airfare and gasoline prices.

The figures will give Sir Keir Starmer's government a boost just two weeks before a tough budget containing steep tax rises is promised. Prime Minister Rachel Reeves is exploring ways to close a $40 billion funding gap, according to a person familiar with the budget process.

The figures have led investors to increase bets that the BoE will cut interest rates for a second time at its November meeting, following a quarter-point cut in August, with further cuts in December.

Based on underlying levels in the swaps market, traders had previously put the odds of two rate cuts by the end of the year at around 50%. This rose to 75% after inflation eased. On Wednesday, the pound fell 0.6% against the dollar to $1.30.

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Paul Dales of Capital Economics said the November cuts already looked set in stone before today's announcement. He added that the quarter-point cut was likely to follow immediately at the next meeting in December.

Aaron Hussein, global markets strategist at JPMorgan Asset Management, said inflation data and cool wage growth show the BoE is gradually taming the inflation tiger.

The yield on British two-year government bonds, which are sensitive to interest rate changes, fell 0.11 percentage points to 4.02%.

Governor Andrew Bailey recently said interest rate setters may be more aggressive in lowering borrowing costs if inflation continues to fall. Investors saw the comments as a sign that the BoE is prepared to cut interest rates at its November and December meetings.

Core inflation was 3.2%, lower than economists' expectations of 3.4%, and the services inflation rate fell from 5.6% to 4.9% due to lower airfares.

The central bank views services inflation as a key measure of underlying price pressures. The 4.9% figure was significantly lower than the 5.5% forecast issued by the BoE when it published its overall assessment of the economy in August.

This is consistent with separate ONS data this week showing UK wage growth falling to 4.9% in the three months to August, down from 5.1% in the three months to July.

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James Smith, UK economist at ING, said the decline in services inflation was big news for the central bank. We think the Bank of England could accelerate its pace of rate cuts beyond November.

Smith added that the rate-cut cycle is likely to accelerate even as headline inflation is likely to rebound to 2.5% later this year as the downturn caused by low energy prices dissipates.

The key comments for the BoE's December meeting will be the shape of Reeves' October 30 budget and the impact of his attempts to control debt.

Chancellor of the Exchequer Darren Jones said Wednesday's inflation figures would be welcome news for millions of households, adding that there was still more work to be done to protect workers.

But given that September's 1.7% figure is due to be used to increase working age benefits next spring, a sharp fall in inflation will hit many low-income families.

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