UK inflation fell to 1.7% in September, a three-year low, causing the pound to drop 0.6% against the dollar to $1.30.
The Office for National Statistics reported that inflation has dropped below the Bank of England’s 2% target for the first time since 2021, prompting speculation about further interest rate cuts.
The lower inflation rate, driven by falling airfares and petrol prices, surprised analysts.
It came in under the expected 1.9% forecast in a Reuters survey and down from 2.2% in August.
Investors now anticipate another rate cut by the BoE in November, following the quarter-point reduction in August, with a possible further cut in December.
Swaps markets now indicate a 75% chance of two rate cuts by the end of the year, up from 50% prior to the inflation report.
Paul Dales at Capital Economics said a November rate cut was “nailed on” before the data release, with the chances of a December cut increasing after the news.
The yield on two-year UK government bonds, which react to interest rate changes, fell 0.11 percentage points to 4.02% after the inflation figures were published.
Chancellor Rachel Reeves faces a challenging Budget in two weeks as the government seeks to address a £40bn funding shortfall.
The lower inflation rate is expected to provide some relief, although steep tax increases are still on the table.
While the drop in inflation might ease pressure on businesses, it could also impact low-income families.
The 1.7% inflation figure will be used to adjust working-age benefits next spring, potentially reducing support for those households.
Nonetheless, BoE officials remain focused on balancing inflation control with economic growth.
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