Is UK inflation past its worst?
Martin Beck, Chief Economist | Economic Consulting and Analysis
At 3.8% September, annual CPI inflation was unchanged from the rate in July and August. While above the Bank of England’s 2% target for the twelfth consecutive month, September’s reading undershot the consensus and Bank of England forecasts of a rise to 4%. And beneath the headline number, there were encouraging signs that underlying price pressures are easing.
Core inflation, which excludes volatile food and energy prices, slipped to 3.5% from 3.6%, while the Bank of England’s gauge of underlying services inflation, a key indicator of domestically generated price pressures, dropped to 3.9% from 4.2% (Figure 1).
Figure 1: CPI inflation was unchanged in September, while underlying measures dipped
Still elevated inflation masks easing price pressures
While inflation still running at close to double the Bank's 2% target is an uncomfortable position for policymakers, September’s reading is likely to give the Bank some reassurance that the UK’s inflation problem is not as chronic as feared. More importantly, it probably marks the peak of the recent inflation upswing
Base effects should push inflation lower over the remainder of this year. In particular, the Ofgem energy price cap, which governs household energy bills, has seen a much smaller rise this month (2%) than in October last year (9%), meaning the year-on-year comparison will now work in the opposite direction than in recent months. We expect CPI inflation to fall back towards 2% in the first half of 2026, as the impact of the passthrough of higher employer National Insurance Contributions and regulated price increases earlier this year drop out of the annual calculation and likely tax hikes in the Budget drag on activity.
What it means for business
For businesses, the outlook suggests gradually easing cost pressures through the remainder of this year and into 2026. Wage growth is moderating, oil prices in sterling terms are currently the lowest since early 2021 and global supply chains appear to have adapted relatively smoothly to a world of higher and more volatile tariffs.
However, the broader operating environment will remain challenging. November’s Budget looks set to deliver a substantial fiscal tightening, dampening demand across the economy. Together with the lingering effects of high interest rates, this will likely constrain consumer spending and investment, even as inflation retreats. Firms should therefore prepare for a period where margins improve only slowly and growth opportunities remain limited.
Our take
A November rate cut from the Bank of England can likely be ruled out given still-elevated inflation and uncertainty over what precisely the Budget will contain. But we think markets are now correct in moving to price a cut in Bank Rate in December, a position we have held for some time. The combination of a looming fiscal squeeze, rising unemployment and softer wage growth points to a weaker demand backdrop than the Bank currently assumes.
With monetary policy working with long and variable lags, a forward-looking central bank should arguably be placing more weight on the disinflationary forces ahead than on inflation readings still reflecting pressures from the recent past.
In our view, this argues for the BoE to start loosening policy sooner rather than later to avoid overtightening and to support what remains a fragile economic expansion.
