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Investors are leaning toward another quarter-point increase in the BOE’s key rate from 5.25% at the meeting on Sept. 21, but doubts on markets over further hikes have mounted in recent weeks. Image Credit: Bloomberg

London: Britain’s inflation rate fell unexpectedly to the lowest level in 18 months, easing pressure for further interest-rate increases from the Bank of England.

The Consumer Prices Index rose 6.7 per cent from a year ago in August, less than the 6.8 per cent gain the month before, the Office for National Statistics said Wednesday. Economists had expected a rise to 7 per cent. Core inflation stripping out food and fuel fell to 6.2 per cent from 6.9 per cent.

The data is a relief for the UK, which for months has had the worst inflation problem in the Group of Seven. They could make it easier for BOE policy makers led by Governor Andrew Bailey to consider an end to their quickest monetary tightening cycle in three decades when they next decide on rates tomorrow. It also may buoy hopes that Prime Minister Rishi Sunak will meet his goal of cutting inflation in half this year.

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The swift surge in the BOE’s benchmark lending rate to 5.25% currently from near zero at the end of 2021 is starting to weigh more heavily on the economy.

“Despite the latest fall, the Bank of England will still be concerned by signs of stubbornly high domestic price pressures,” said Alpesh Paleja, lead economist at the CBI, Britain’s biggest business lobby group. “As a result, another rise in interest rates tomorrow still looks more likely than not, though changes to monetary policy beyond this will be very data dependent.

The pound fell as much as 0.5 %

to $1.2334, its lowest level since May as traders bet the BOE is nearing the end of its hiking cycle.

The chance of a quarter-point increase on Thursday also fell, with the market assigning a less than 60 per cent probability of a hike, down from 90 per cent earlier, according to swap pricing.

“We expect the Bank of England on Thursday to somewhat emulate the ECB and hike the Bank Rate one last time,” said Geoff Yu, forex and macro strategist for EMEA at BNY Mellon. “The move will likely be construed as a ‘dovish hike’ and this would be reinforced by the soft CPI print for August.”

This month’s report confounded expectations for a small uptick in prices due to an increase in fuel. It confirmed that the BOE’s effort to rein in inflation is gaining traction.

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While August’s lower-than-expected inflation reading will have cheered BOE policy makers, economists said it was too early to celebrate yet.

“With oil prices rising briskly in September, we can expect unhelpful monthly gains here that slow the deceleration in headline CPI,” said Melissa Davies, chief economist at Redburn Atlantic. “Taking a step back, inflation remains far too high in the UK but will continue easing into the end of the year.”

The BOE’s real challenge, she added, would be getting inflation down from 4 per cent to the 2 per cent target.

Services inflation eased to 6.8 per cent from 7.4 per cent, which may relieve upward pressure on wages that has especially concerned the BOE. Officials were concerned that rising pay and prices across service industries were embedding inflationary pressures in the economy.

“The rate of inflation eased slightly this month driven by falls in the often-erratic cost of overnight accommodation and air fares, as well as food prices rising by less than the same time last year,” said ONS chief economist Grant Fitzner.

The swift surge in the BOE’s benchmark lending rate to 5.25 per cent currently from near zero at the end of 2021 is starting to weigh more heavily on the economy.

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Official data and surveys show activity contracted in the first few weeks of the third quarter, reviving the risk of a recession.

The darkening mood is the latest headache for Sunak’s Conservative administration, which is trailing the Labour opposition in polls little more than a year before the most likely date for the next election. Sunak has made cutting inflation in half one of his five key priorities, but he’s also anxious to deliver growth to voters unsettled that their living standards are being squeezed.

“The plan to deal with inflation is working - plain and simple,” Chancellor of the Exchequer Jeremy Hunt said in a statement. “But it’s still too high, which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses. It is also the only path to sustainably higher growth.”

Pipeline price pressures continued to ease, despite higher oil prices pushing producer input and output prices higher on the month. Compared with a year earlier, the cost of fuel and raw materials fell 2.3 per cent, while the price of goods leaving factory gates declined 0.4 per cent.