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The sharp drop in inflation to just 1.7%, the first sub 2% reading since April 2021, effectively nails on a 25 basis points (bps) rate cut next month. Inflation will rebound a little from here as base effects and higher energy prices take effect, but it will stay below 3% and slowing services inflation will allow the Monetary Policy Committee (MPC) to gradually cut interest rates over the next year.

Key drivers behind drop in UK inflation

The drop in inflation to 1.7% leaves it a whopping 0.4 percentage points (ppts) below the last MPC forecast. Falling fuel prices helped push the headline rate lower. The cost of filling up at the pump fell by 3.9% on the month having risen by 3.6% at the same point in 2023.

Services inflation dropped back to 4.9%, its lowest reading since May 2022 and core inflation dropped to 3.2%. Airfares were a key source of downward pressure in the category, falling 34.8% on the month, having dropped by 23.2% in September 2023.

Excluding airfares, package holidays and education — a measure the Bank of England (BoE) has in the past called ‘core’ services inflation — as well as accommodation services, which tend to be volatile, annual services inflation fell to 5.3%, from 5.5% based on our estimates.

The key takeaway is that the headline measure of services inflation overplays the loss of momentum in domestically generated cost pressure in September’s data. Underlying measures point to a slower easing, however there is still further progress in the pipeline.

Disinflation and interest rates - what next?

Inflation will rebound later this year as favourable base effects fall out of the annual comparison. Some of the more erratic factors that pulled down inflation in September unwind and energy prices move higher. But this morning’s data is clear evidence that disinflation is continuing to move through the economy at pace and should reassure the BoE that it can cut interest rates more aggressively without stoking higher inflation.

The policy takeaway

A rate cut in November looks like a near certainty. The bigger question is whether it will be followed by another in December with the central bank indicating that it is comfortable moving sequentially.

The Autumn Budget will play a big role in whether that scenario plays out. We think fiscal policy will be loosened relative to the plans set out in the March budget. If that’s right, and underlying inflation continues to cools slowly, the BoE will be more likely to stick to quarterly cuts next year. 

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