Inflation falls to its lowest level in three and a half years – what is the impact?

Inflation has fallen to 1.7% in September – its lowest level in three and a half years, boosting hopes that the Bank of England may soon cut interest rates again. But the lower rate will also affect the increase in welfare benefits next year.

The UK has been struggling through the worst cost of living crisis in 4 decades, so many people will be hoping that today’s figure is the strongest evidence so far that the big squeeze is finally over.

Just over 2 years ago, inflation peaked at 11.1% – way above the government’s target of 2%.  It has slowly edged down since then – going below the target today for the first time since April 2021.  But we’re not just back to target but significantly below it.

That is stoking expectations in the financial markets that the Bank of England, who’s job is to hit that 2% target, can now ease off some more on high interest rates.

The Bank has already cut rates once from 5.25% down to 5%.  Now City investors think it could cut again in November and possibly in December as well.

City predictions about what the Bank of England will do are not always right – but if this does happen, then the squeeze on mortgages could be easing alongside the squeeze on household bills.

Problems ahead?

Falling inflation will be welcome news for a lot of people. But falling inflation doesn’t mean falling prices – it means those prices are going up at a slower pace.

The rate of food inflation edged slightly higher this month – from 1.3% to 1.9%. And rents are going up at more than 8 percent a year.

There was also a very specific influence on this month’s inflation rate: airfares.

They dropped a lot between August and September. But airfares are often volatile, so there is a chance this big drop could suddenly reverse itself in future months.

But the biggest worry for inflation is energy prices: they are set to rise because Ofgem’s cap on domestic gas and electricity bills went up on October 1st by 10%.

The effect of that will appear in the October inflation figures, which come out next month and many economists think on its own, this could push inflation back up to 2.2%.

So September may be the trough for inflation.  And that may make the Bank of England just a bit more cautious about how quickly it can bring down interest rates.

Benefits impact

The September inflation rate is used to decide how much working age benefits go up by next April. 10 million UK households get some benefits so this matters to a lot of people.

They will see a very small increase because inflation in this month is so low. And that will become more of a problem if inflation does now start to rise.

The Resolution Foundation today calculated that for a low income family with 2 children, they can expect an annual increase of £253 based on today’s inflation rate.

But as the graph below shows, if benefits went up by 2.2% – the inflation rate we may have next month – they’d get an increase of £327.

An extra £74 may not be a huge amount, but these are households with an income around 15 thousand pounds a year: so every pound matters.

The Resolution Foundation says September’s low inflation is badly timed for these families, and it asks whether it still makes sense to link the benefits that millions rely on with one month’s inflation data.