UK Inflation Steady in August; Services Sector Inflation Rises, Impacting BoE Rate Decision

British inflation held steady in August, with the Consumer Price Index (CPI) remaining at 2.2%—matching expectations but falling short of the Bank of England’s (BoE) latest projection of 2.4%. However, a notable increase in services sector inflation has added complexity to the central bank’s upcoming decision on interest rates.

Consumer Inflation Unchanged; Services Sector Sees Acceleration

The Office for National Statistics reported that CPI for August was unchanged from July, aligning with the median forecast of economists surveyed by Reuters. Despite this, services inflation—a key indicator of domestic price pressures—increased to 5.6% from 5.2% in July. This rise exceeded the expected 5.5% and reflects underlying inflationary trends within the economy.

A significant contributor to the rise in services inflation was a sharp 22.2% increase in airfares between July and August. The Office for National Statistics noted that this was the second largest jump in airfares since records began in 2001.

Market Reactions and BoE Rate Expectations

In response to the inflation data, the British pound strengthened against the U.S. dollar. Market participants adjusted their expectations for the BoE’s upcoming interest rate decision, reducing the likelihood of a rate cut on Thursday to approximately 26%, down from more than one in three before the data release.

Despite the shift in expectations, rate futures still indicate that investors anticipate two quarter-point rate cuts by the end of 2024. The BoE had previously lowered borrowing costs from a 16-year high of 5.25% to 5.0% in August. The central bank has signaled a cautious approach to further reductions, considering that wage growth—a significant driver of inflation in the services sector—is only gradually slowing.

Looking Ahead

Although overall inflation remains steady, the acceleration in services prices presents a challenge for the BoE. Economists note that excluding volatile items such as airfares, the trend in services inflation continues to weaken, which may influence the central bank’s strategy moving forward.

The BoE’s decision on Thursday will be closely watched, as policymakers balance the need to manage inflation with the broader economic conditions. The central bank’s approach will likely reflect ongoing concerns about wage growth and its impact on domestic price pressures.