UK inflation slowed less than expected last month as fuel prices crept higher, prompting traders to unwind bets on interest rate cuts.

Consumer prices rose 3.2% in March compared with a year earlier, down from 3.4% in February, the Office for National Statistics (ONS) said on Wednesday. While it was the lowest since September 2021, it was above the 3.1% that the Bank of England (BOE) and private-sector economists had expected.

The figures underscored skittishness about when the BOE will be able to ease off on the highest interest rates in 16 years. A surprise jump in price pressures in the US last week prompted Fed chair Jerome Powell to warn that rates there may stay higher for some time, reordering market expectations around the globe.

“UK inflation continues to trend in the right direction, but at a slower pace than expected,” said Matthew Landon, global market strategist at JPMorgan Private Bank. “This print shows that fairly broad-based upside surprises likely edges us in the direction of later cuts.”

Traders in the UK significantly pared bets on interest-rate cuts from the BOE, moving to favour just one quarter-point reduction this year. Swaps fully price a cut by November and see just over a 30% chance of a second move. That’s a sharp change from just a few weeks ago when two or three cuts were on the cards.

The pound gained as much as 0.3% to US$1.2466, reversing earlier losses after the data and snapping three days of declines.

“The upside surprise in the UK’s March inflation data doesn’t change our view that annual CPI is likely to reach the 2% target in coming months. Still, there were signs of continued stickiness in services prices. That reduces the chances there will be a sustained period of below-target inflation this year,” said Dan Hanson and Ana Andrade at Bloomberg Economics.  

Britain had the worst inflation problem in the Group of Seven nations last year but has brought down the pace of price increases sharply from 11% in late 2022. Governor Andrew Bailey and his colleagues expect it to drop to the 2% target later this year, but they’re looking for more firm evidence that those pressures will subside before acting.

Speaking at the International Monetary Fund in Washington on Tuesday night, Bailey noted a “divergence” between the US economy and those in Europe, a hint that the BOE might be able to ease policy before the Fed. Yet Wednesday’s figures were a reminder of his previous warnings that it may take some time to ensure inflationary forces are suppressed.

“There is still some way to go before inflationary pressures are squeezed out of some sectors of the economy,” said Roger Barker, director of policy at the Institute of Directors. “Nonetheless, the trend is clear and the case for a cut.”

The ONS said food prices rose less than a year ago, putting downward pressure on inflation. This was partially offset by an increase in the cost of motor fuel.

Core inflation, which excludes energy, food, alcohol and tobacco, fell to 4.2% last month from 4.5%. That also was stronger thaN economists had expected. Meanwhile, inflation in the services sector - watched by the BOE for indications of domestically driven price pressures - eased to 6% from 6.1%. The BOE and economists had expected a decline to 5.8%.

“Today’s core inflation indicates that underlying inflationary pressures continue to ease, but remain above their historical average,” said Paula Bejarano Carbo, an economist at the National Institute of Economic and Social Research. “With inflation set to fall further in April, the MPC will be closely watching movements in core CPI ahead of its upcoming meetings.”

Bailey since February has opened the door to lower rates. But others on the nine-member Monetary Policy Committee have urged caution. Those include Megan Greene, who warned last week that a reduction “should still be a way off”. 

“Though this inflation fall won’t be sufficient to drive a cut in interest rates next month, this outturn may persuade more rate setters to vote to loosen policy, providing a clear signal that rate cuts are on the horizon,” said Suren Thiru, economics director at Institute of Chartered Accountants in England and Wales.

Separate data showed pipeline price pressures easing, with the cost of fuel and raw materials used by producers falling 2.5% in March from a year earlier. The price of goods leaving factory gates rose just 0.6%.

There were stronger pressures in the services sector, where producer prices rose 3.6% in the first quarter from a year earlier. That’s up from 3.5% in the previous quarter.

On Tuesday, a report on the labour market showed unemployment rising sharply but wage pressures persisting more strongly than economists had expected. The economy also picked up momentum in the first two months of the year after a recession at the end of 2022. Businesses and consumers are hoping rate cuts will bolster that growth.

“Inflation is going in the right direction, but we can’t be complacent about the state of the economy,” said Pranesh Narayanan, research fellow at Institute for Public Policy Research. “Unemployment is ticking up. We still have record levels of people who are too sick to work, a cost-of-living crisis and stagnant growth. It’s time for the Bank of England to cut interest rates.” 
 

  - Bloomberg