Inflation drop raises questions over interest rate rise

The UK’s inflation rate unexpectedly fell to a 12-month low last month, prompting some economists to question the need for the Bank of England to embark on the expected phased increase in interest rates in May.

Bank of England: Pound coins
Data from the Office for National Statistics (ONS) on Wednesday showed the consumer prices index (CPI) dropped to 2.5 per cent in March, down from 2.7 per cent in February. Analysts had forecast no change over the month.

Average earnings continues to increase in the UK

The inflation data followed publication of the latest employment figures on Tuesday which, aside from showing the number of people in work had reached a record high of 32.2 million while the total of jobless was at its lowest in a decade, recorded average earnings increasing at 2.8 per cent in the year to February.Tej Parikh, senior economist at the Institute of Directors, said the drop in inflation could spur growth in the UK economy, “Today’s figures show a significant drop in inflation, and it is expected to continue to fall over the course of this year. This will be welcomed by the business community who have seen high inflation act as a major speed bump on economic growth ever since the beginning of last year.“The drop in inflation will also offer much-needed breathing space for households who have been wedged between weak wage growth and rising price levels, which in turn will hopefully bolster consumer confidence and sales activity.”
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Alan Clarke, economist at Scotiabank, said that the fall in inflation would be good news for growth as household real incomes growth accelerates and boosts spending. But he added, “The flipside is that the market is likely to question the likelihood of BoE rate hikes, both near term and later in the year.“Even if the MPC does look through the low reading on this occasion and hike rates in May, this dilemma is likely to continue over the remainder of the year.”Suren Thiru, head of economics at the British Chambers of Commerce, agreed that the fall in inflation undermined the case for raising UK interest rates next month. Such sentiments led to sterling losing some of its recent gains against the dollar. Philip Smeaton, chief investment officer at wealth manager Sanlam UK, commented, “With inflation falling back towards the Bank of England’s 2 per cent target and wage growth overtaking inflation for the first time in over a year, it finally looks like the squeeze on living is easing.“These positive signs of a strengthening economy could be all the Bank of England needs to pull the interest rate lever in May – moving policy back towards monetary normalisation. However, the MPC should consider what impact this could have on consumer debt.“Since the shock vote to leave the EU, consumers have continued to spend despite immense pressure on their pockets – meaning they have likely accumulated debt. Should too much pressure be applied through higher interest rates this could impact consumers ability to spend, which is a vital element of the UK economy.”

Family disposable income remains squeezed

Alistair Wilson, head of retail strategy at Zurich, added, “While households can breathe a sigh of relief thanks to another easing of inflationary pressures, family disposable income remains squeezed, particularly after the news that disposable income has fallen for the first time in six years.“Even with the inevitable rate rise, it’s clear that more needs to be done to help make what little savings people can afford to put away, go that bit further.”Mike Hardie, head of inflation at the ONS, attributed much of the fall in the RPI to price increases in clothing and footwear tapering off. “Alcohol and tobacco also helped ease inflation pressures, with tobacco duty rises linked to the Budget not appearing this March, thanks to its new autumn billing,” he said.
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