The Office for National Statistics said consumer prices rose by 1.3% in the year to December, down from 1.5% the previous month. The consensus in financial markets was that there would be no change in the rate so the surprise fall prompted a drop in the pound, which was trading 0.2% lower at $1.2990, a sign that traders think a rate cut is now far more likely.
The statistics agency said the main downward pressure on inflation came from accommodation services and clothing. A number of the Bank of England's nine rate-setters, including outgoing Governor Mark Carney, have hinted recently that the main interest rate could be cut from 0.75% at the next policy meeting on Jan. 30 as growth is lackluster due to Brexit uncertainty and inflation is below target. The central bank is tasked with setting interest rates to achieve an inflation rate of 2%.
In a speech on Wednesday before the inflation figures were published, rate-setter Michael Saunders indicated that he will continue to back a rate reduction. Saunders, who has backed a quarter-point interest rate reduction at the last two policy meetings, also suggested that the central bank may have to do more to prevent inflation undershooting the target for too long, especially at a time of “softer global growth.”
“It probably will be appropriate to maintain an expansionary monetary policy stance and possibly to cut rates further, in order to reduce risks of a sustained undershoot of the 2% inflation target.” he said. “With limited monetary policy space, risk management considerations favor a relatively prompt and aggressive response to downside risks at present.”
One factor that could encourage rate-setters to hold off a rate cut is the greater Brexit clarity that has emerged since last month's convincing election win for Boris Johnson's Conservatives. That has the potential to shore up the British economy this year following a tepid 2019, when it is estimated to have grown about 1%.
With an 80-seat majority in the House of Commons, Johnson has been able to drive through his Brexit withdrawal deal with the European Union so the country leaves the bloc as scheduled on Jan. 31. Britain will remain within the EU’s economic arrangements, including the tariff-free single market and the customs union, until the end of 2020, during which time Johnson hopes to conclude a wide-ranging trade agreement with the EU.
Though that timeframe is considered optimistic by many experts, the election result at least provided clarity about the immediate future. There had been concerns that Brexit uncertainty, which has hurt business investment in particular, would persist or worsen if the election was inconclusive.
“Political risk has hobbled the (Bank of England) but this has diminished greatly and now is the window — before a possible clash with the EU in the spring that would make policy changes more political in nature — to get a cut in the bag to juice the economy,” said Neil Wilson, chief market analyst for Markets.com.