UK inflation: What a steady 3.8% rate means for interest rates and mortgages

The annual measure of consumer prices index (CPI) inflation came in at 3.8 per cent for August, the same reading as July, according to the latest data from the Office for National Statistics (ONS). That was in line with what most analysts had been expecting.

However, Bank of England policymakers, who will meet on Thursday to give their latest decision on interest rates, will be concerned about food prices, which have accelerated for the fifth month in a row. The ONS figures showed that the annual rate of food and drink inflation rose to 5.1 per cent in August, from 4.9 per cent the month before, as shoppers continued to face higher prices for many items at the till.

That headline CPI rate at 3.8 per cent is also almost double the central bank’s 2 per cent target, and officials expect it to spike at 4 per cent or slightly above before easing back again.

Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK, said: “Stable inflation in August in line with the Bank of England’s forecast and a slightly bigger-than-expected fall in services inflation is good news, but it won’t make much difference to the Bank’s monetary policy committee (MPC).

“The drop in services inflation was largely due to the reversal of the jump in airfares in July and inflation is still set to reach 4 per cent in September. That will make it difficult, although not impossible, for the MPC to cut rates again this year. However, we think February is the most likely chance for the next rate cut.”

Professor Joe Nellis, economic adviser at MHA, the accountancy and advisory firm, said hopes of an interest rate cut this month had been dashed but he held out some hope of a further reduction before the end of 2025. After this Thursday, the MPC is due to gather on two more occasions before the year-end - on November 6 and just before Christmas on December 18.

“Today’s figures are not good viewing for those hoping for a cut to interest rates when the MPC meets [on Thursday]. With wage growth and services inflation running hot, the MPC is very likely to keep rates on hold.

“However, given the economy is growing slower than desired, we expect at least one more interest rate cut before the end of the year - as long as inflation doesn’t escalate much further. This sets the stage for the autumn Budget. Persistent inflation is keeping gilt yields elevated, which means higher debt-interest costs for the Treasury and even slimmer fiscal headroom for the Chancellor.”

The inflation data showed airfares coming down after a spike the previous month, helping to offset petrol and diesel prices which edged higher in August. Restaurants and hotels also put upward pressure on the overall rate as demand for meals out and overnight stays stayed high amid a string of popular concerts around the UK.

Food items such as vegetables, milk, eggs, cheese and fish helped put pressure on the overall rate of inflation in August.

Kevin Brown, savings expert at Glasgow mutual Scottish Friendly, described the unchanged headline inflation reading as a “welcome surprise” but said the cumulative effect of price rises over the past few years meant that household budgets remain stretched.

“While inflation is no longer rising, it doesn’t make another rate cut any likelier this year,” he added. “The monetary policy committee has been insistent that it will proceed cautiously on future rate cuts, with policymakers wary of another price spiral if they move too soon.

“Realistically, we won’t see the next cut until March or April next year now, which will come as a blow to borrowers holding out for a further reduction in borrowing costs before switching to a new mortgage rate.

“For savers, the challenge remains the same. Even flat inflation eats away at the value of cash, and with savings rates softening, it is vital they shop around for the best rates or consider long-term investments that offer the potential for stronger returns and better protection against inflation.”

Mortgages

Mortgage experts said two more quarter-point cuts to the bank base rate had been factored into the deals offered by lenders.

Peter Stimson, director of mortgages at MPowered, noted: “While the mortgage swaps market, which tracks interest rate expectations and is used by mortgage lenders to determine the fixed interest rates they offer to borrowers, still suggests there will be two more base rate cuts in total, the timing could now be pushed into next year.

“The awkward truth is that mortgage interest rates may have fallen as far as they can. Some lenders have inched up their rates in recent weeks, and today’s blowout inflation number will do nothing to reverse that trend.”

ONS chief economist Grant Fitzner said: “The cost of airfares was the main downward driver this month with prices rising less than a year ago following the large increase in July linked to the timing of the summer holidays.

“This was offset by a rise in prices at the pump and the cost of hotel accommodation falling less than this time last year.

“Food price inflation climbed for the fifth consecutive month, with small increases seen across a range of vegetables, cheese and fish items.”

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