The Bank of England base rate could fall sooner and more dramatically than previously predicted after a bigger than expected dip in inflation.
Headline inflation fell to 3.9 per cent in November, according to data released on Wednesday, far below the 4.3 per cent that economists had suggested.
Markets have now fully priced in the chance of the Bank of England base rate – which determines the rate at which it lends to other banks – dropping from 5.25 to 5 per cent in May, with some forecasters who had predicted falls later in the year revising their estimates. Some traders are even pricing in a strong chance of a March cut.
An earlier than expected rate drop would be welcome news for the 1.5 million mortgage holders who will have to move on to new deals next year, because these people may see their costs go up by less than expected if the predictions come to fruition.
The movement in the markets come after Work and Pensions Secretary Mel Stride said the steeper than expected inflation drop would allow the Bank to ease interest rates sooner than planned.
Currently, markets expect that rates will drop by 1.36 percentage points over the next year – compared with predictions of a 1.07 percentage point decline last Friday.
A 1.36 percentage point reduction would cut interest rates to 3.89 per cent, though in practice, reductions usually come in 0.25 percentage point blocks, so this would mean the base rate could fall to 4 per cent by the end of next year.
David Blanchflower, an economist who sat on the Bank of England’s Monetary Policy Committee between 2006 and 2009 – and consistently voted to cut interest rates – told i he believed the latest inflation figures would force the banks hand and lead to a first bank rate cut in March.
“My guess would be a cut in March, given strong words again by Andrew Bailey and three hawkish dissenters. Their hand will likely be forced by the Fed [the US Central Bank] when they first cut,” he said, as well as criticising the Bank’s decision to keep rates at a high level for so long, at what he said was the detriment of the economy.
Ashley Webb, an economist at Capital Economics said: “The recent string of softer-than-expected wage and inflation data mean the Bank may not wait as long as our forecast of late in 2024 to cut rates.”
And he added that the data would “further fuel market expectations that the Bank of England will start cutting interest rates as early as May 2024”.
Dr Muhammad Ali Nasir, an associate professor of economics at the University of Leeds, told i that the current inflation picture “reinforced his view that rate cuts should be sooner than predicted”.
He had previously told i that if inflation continued to fall dramatically, rates would have to be cut in February. Asked if that was still the case, he said: “It will also depend very much on the next release of inflation statistics before the February announcement. But I think the case for a rate cut sooner is very strong.”
Raj Badiani, economics director for Europe for S&P Global Market Intelligence, told i the organisation was forecasting an August cut to interest rates at the moment, but that “the balance of risks is now tilting towards the possibility of an earlier cut in May or June”.
He said the Bank of England would want to see “strong evidence that the impact of the energy price shock on price setting elsewhere has dissipated”.
But he added: “On the brighter side, today’s inflation release provides some support to our call of four cuts in 2024.”
Minister Mr Stride told LBC Radio that the latest fall in inflation was “really good news” and “a turning point”.
He added: “A greater decrease in inflation of course means that monetary policy might be loosened a lbit more quickly than it would otherwise be – in other words, interest rates coming down.
“Those are matters for the independent Bank of England, they are not for me to predict, but if inflation comes down faster than expected, then that does take some pressure off the Bank of England in terms of keeping interest rates higher, which of course, in time and in turn, feeds into mortgage rates.”
But Edward Jones, professor of economics at Bangor University, urged caution, telling i: “The data is going in the right direction, but central bankers will still be very cautious about ensuring they have seen inflation off.
“Everybody will be in agreement there will be cuts but it’ll be around the time of September I would expect, let’s not get ahead of ourselves.”
Michael Saunders, another former Bank of England rate-setter, also told i that he did not expect the rate to quite reach 4 per cent next year.
“Market pricing may have gone a little too far,” he said. “I would go for four cuts next year – to 4.25 per cent – but the key point is that lower inflation should allow interest rates to fall significantly.”
Mr Sunak staked his premiership on five key pledges at the start of the year, including a promise to halve inflation by the end of 2023. It is likely to be the only one of the five pledges that he will meet, with inflation well down from the 10.7 percent at the start of the year.
Mortgage experts said the inflation data would continue to push mortgage rates downwards, because of the expectation that it would mean the Bank of England pushing down interest rates quicker.
David Hollingworth, associate director at L&C Mortgages, said: “As market expectation of the chance for the next move in base rate to be down has grown, lenders have passed through improvements in funding costs.”
He added: “Today’s news is likely to further that trend, which could soon see five-year fixed rates soon closing in on the 4 per cent marker. That would be a big boost for homeowners coming towards the end of their current, low fixed rates and bracing themselves for the inevitable hike in monthly payments.”
Some of the country’s biggest mortgage lenders have been slashing rates in recent weeks to try to attract customers in the face of stalling business.
Mr Hollingworth warned that those coming off cheap deals signed during the pandemic period – when some mortgage rates were lower than 1 per cent – would still see an increase in their costs, but added: “It will at least feel a little more manageable than the peaks we saw during the volatility of the summer.”
A reduction in interest rates would also push down tracker mortgage rates – which follow the Bank of England base rate – and variable deals, which tend to.
These variable costs have been high for months, with many facing interest rates of above 9 per cent – and so a drop for these customers would be welcomed.