The odds of the Bank of England cutting interest rates in May have been strengthened after inflation cooled by more than forecast last month.
In a boost for Rachel Reeves on the day of the chancellor’s spring statement, the Office for National Statistics said inflation as measured by the consumer prices index eased to 2.8% in February from 3% in January.
City economists had predicted a modest decline to 2.9%, after a sharp rise from 2.5% in December amid mounting pressure on households from higher energy bills and the rising cost of groceries. The figures indicate prices are continuing to climb on an annual basis, albeit at a slower rate.
With inflation remaining above the Bank’s 2% target, and amid expectations of an increase in the headline rate later this year, the prospect of Threadneedle Street using its next policy meeting in May to cut rates is finely balanced.
However, City traders added to bets on rate cuts in response to the latest snapshot, leading financial markets to price in a 55% chance of the central bank lowering its key base rate by a quarter of a percentage point to 4.25% on 8 May.
Grant Fitzner, the ONS chief economist, said that clothing prices, particularly for women’s clothes, was the biggest driver for February’s fall in inflation. He added: “This was only partly offset by small increases, for example, from alcoholic drinks.”
The figures were published only hours before the chancellor’s address to the Commons, in which Reeves presented gloomy forecasts for the economy and public finances from the Office for Budget Responsibility.
Britain’s economy has come close to stagnation in recent months as households remain under pressure from high prices and elevated borrowing costs. Business and consumer confidence has also fallen sharply amid concerns over the impact of government tax increases and Donald Trump’s trade wars.
Inflation is expected to rise again amid an increase in wholesale energy costs and climbing food prices, in a renewed squeeze for households. The Bank has warned that inflation could hit a fresh peak of about 3.7% later this year.
Households are braced for a sharp rise in council tax, utilities and other bills from April. Business leaders are also warning that Reeves’s autumn budget increase in employer national insurance contributions, due to take effect from next week, will force companies to cut jobs and increase prices.
“February’s slowdown is a false dawn as notable near-term price rises are already baked in, with next month’s jump in energy bills and national insurance likely to push inflation perilously close to 4% sooner rather than later,” said Suren Thiru, the economics director at the Institute of Chartered Accountants in England and Wales.
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Paul Dales, the chief UK economist at the consultancy Capital Economics, said inflation could drop back to 2.5% in March but that a 6.4% monthly rise in utility prices and 26% monthly leap in water bills would drive it up above 3% in April.
Stubbornly higher inflation is expected to limit the Bank’s capacity to cut interest rates, and is reflected in higher government borrowing costs on financial markets in a headache for the chancellor.
The latest snapshot showed core inflation – which excludes food and energy and measures underlying price pressures, was 3.5% in February, down from 3.7% a month earlier. Inflation in the services sector, which is closely watched by the Bank, was unchanged at 5%.
Threadneedle Street has said it will take a “gradual and careful” approach to cutting interest rates. After three reductions in the past year, City investors predict only two more quarter-point rate cuts this year, to 4%.
Darren Jones, the chief secretary to the Treasury, said the government was focused on “delivering economic stability” to secure people’s finances. “Our No1 mission is kickstarting growth to raise living standards for working people, that is why we are protecting working people’s payslips from higher taxes.”
