Inflation Roulette: Will UK Inflation Crash Below Target, Triggering a Rate Cut?

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UK Inflation Poised to Plunge, Sparking Interest Rate Cut Debate

Prepare for a significant milestone in the United Kingdom’s battle against inflation. Experts predict a sharp decline in the April inflation report, potentially bringing the headline rate below the Bank of England’s coveted target of 2%. This would mark a dramatic departure from the current 3.2% and could lay the groundwork for an interest rate cut as early as June.

Energy Cost Relief Drives Drop

The primary driver behind this projected drop is the energy sector. The regulator-set cap on household electricity and gas bills decreased by a significant 12% at the start of April. This reduction will lead to lower energy costs, which will ripple through the economy, lowering overall prices.

A headline inflation rate below 2% on Wednesday would represent the lowest level since April 2021. It would also signal a substantial cooling from the peak of 11.1% reached in October 2022, when the UK faced some of the most severe price increases among developed economies.

A Range of Inflationary Pressures

The UK has grappled with a complex mix of inflationary forces. A tight labor market, a weaker currency driving up import costs, and steeper gas price hikes than elsewhere have all contributed to the high inflation rates.

‘Momentous’ Milestone

Ashley Webb, a UK economist at Capital Economics, believes that a drop below 2% in April would be “momentous.” He anticipates that this event would be decisive in determining whether the first interest rate reduction from 5.25% will occur in June or August.

A Reuters poll of economists projects a slightly higher inflation rate of 2.1%. Meanwhile, the Bank of England has maintained its cautious stance, signaling a summer rate cut without committing to June as the European Central Bank has done.

Time for a Rate Cut?

BOE Governor Andrew Bailey has acknowledged the encouraging inflation figures, but emphasizes the need for further data before making a decision about the June meeting. BOE Deputy Governor Ben Broadbent has suggested that a rate cut could occur over the summer if inflation continues to align with forecasts.

As of Tuesday, money market indicators indicated a 50% probability of a June cut, increasing to 73% in August.

Market Overreaction Risk

ING economists believe inflation will hover just below 2% in April and May, remaining low throughout the rest of the year. This trajectory is significantly below the BOE’s own forecast of 3% by year’s end.

James Smith, ING’s developed markets economist, anticipates multiple rate cuts this year, with the possibility of three or more. However, he warns of market overreaction to a low headline print on Wednesday.

Jane Foley, head of FX strategy at Rabobank, highlights the importance of core and services inflation metrics in shaping the timing of the first rate cut. If service inflation remains elevated, the Bank of England may delay a cut until August.