UK Inflation Falls to 3% – Interest Rate Cut Now Highly Likely in March

UK Inflation Falls to 3% – Interest Rate Cut Now Highly Likely in March

Bank of England expected to lower base rate to 3.5% as price pressures ease

UK inflation has fallen sharply to 3%, strengthening expectations that the Bank of England will cut interest rates next month. Financial markets are now pricing in an 81% chance of a reduction in March, with further cuts possible later this year.

The latest data from the Office for National Statistics shows the Consumer Price Index (CPI) dropped to its lowest level since March last year. While prices are still rising, they are doing so at a slower pace, bringing inflation closer to the Bank’s 2% target.

Why Inflation Has Fallen

The decline in inflation was driven largely by falling energy and travel costs, along with easing food price pressures.

Key contributors include:

• Lower petrol prices, reflecting weaker global oil markets
• Cheaper airfares compared with previous months
• Slower increases in food prices, particularly meat, bread and cereals

However, inflation remains elevated in parts of the services sector, including hotel stays and takeaway food. Services inflation slowed to 4.4%, but not as much as economists had forecast.

What Happens Next for Interest Rates?

The Bank of England currently holds the base rate at 3.75%. Markets now expect:

• A rate cut to 3.5% in March
• A potential second cut to 3.25% in September
• Some forecasts suggesting rates could fall to 3% by the end of the year if the labour market weakens

While several economists see a spring rate cut as highly likely, others caution that stubborn services inflation may limit how quickly rates can fall.

The Bank adjusts interest rates based on progress towards its 2% inflation target. With CPI trending lower, policymakers may feel more confident easing monetary policy.

How This Could Affect Mortgages, Savings and Shares

A rate cut would have direct implications for households and investors.

For consumers:

• Mortgage rates may gradually fall, easing pressure on borrowers
• Savings rates could decline, reducing returns for deposit holders
• Student loan repayments linked to interest rates may become slightly cheaper

For financial markets and share prices:

• Lower rates generally support equity markets by reducing borrowing costs for businesses
• Consumer-focused stocks may benefit from improved spending power
• Property and housebuilding shares could see renewed interest as mortgage costs fall
• Bank shares may face pressure if lower rates reduce net interest margins

In short, a rate cut tends to be positive for growth-oriented sectors but more mixed for financial institutions.

Outlook: Further Falls in Inflation Expected

Economists widely expect inflation to decline further in the coming months. The Bank of England has indicated that CPI could move “around” the 2% target by April. Independent analysts suggest inflation may stabilise near that level for the first time since before the pandemic.

However, risks remain. A rebound in energy prices or persistent wage pressures could slow the pace of easing.

Market Implications Over the Next 12 Months

If inflation continues to fall and rates are cut steadily, the UK stock market could benefit from:

• Improved corporate profitability due to lower financing costs
• Stronger consumer confidence
• Increased investor appetite for risk assets

While not guaranteed, the current trajectory points towards a more supportive environment for equities compared with the high-rate conditions of recent years.

Investors will now watch upcoming Bank of England meetings closely, as March could mark the beginning of a new interest rate cycle.

Sources: (BBC.co.uk, SKY.com)