UK reaction: Food and restaurants & hotels drive down the headline rate

The CPI inflation reading for February likely provided further relief to the Bank of England, with the headline rate slowing to 3.4% in February ‑ the lowest rate since September 2021 – from 4% in January, below both the consensus and the MPC’s February forecast, of 3.5%. Core CPI inflation also fell, dropping to 4.5%, from 5.1% in January, again below the consensus, 4.6%. RPI inflation fell to 4.5% whilst RPIX (Retail Price Index excluding mortgage interest payments) fell to 3.5%.

The slowdown in the headline rate was largely driven by a deceleration in food and restaurants and hotels inflation. Indeed, a decline in food inflation to 5.0%, from 6.9%, shaved off 0.23pp from the headline rate on the back of strong gains this time last year, while the fall in restaurants and hotels inflation to 6%, from 7% ‑ driven by the price of alcohol at restaurants and cafes ‑ knocked off a further 0.13pp. The overall easing in inflation was, partially offset by rising housing and household services inflation, with the annual rate for actual rentals for housing increasing to 6.9%, from 6.5%. But the MPC will likely be more focussed on the 0.4pp overall fall in services CPI inflation – which closely reflects domestic inflationary pressure – to 6.1%, from 6.5%, bang in line with their expectations in the February MPR.

Looking ahead, a further slowdown in CPI inflation looks likely, with core goods inflation set to drop back to around zero by the middle of the year and food inflation slowing further. In addition, energy CPI inflation will knock 0.6ppt off the headline rate in April. Admittedly, services CPI inflation likely will remain above the 3% to 3.5% range that is likely necessary to sustainably return the headline rate to the 2% target for most of the year, with the 9.8% increase in the National Living Wage in April likely putting some upward pressure on pay growth and labour market slack taking time to develop. By the end of the year, though, this too should be moving back towards levels consistent with the long-term mandate. We expect CPI inflation to average 2.3% this year and next. 

We continue to think the MPC will keep Bank Rate unchanged at 5.25% tomorrow, with the 3-way split seen for the first time since 2008 likely to remain, although there is some risk that support for another hike will fade at this meeting. In addition, we continue to think the first cut will come in August, alongside the MPC’s next forecast round, rather than earlier in June. We also still expect two further cuts in November and December, leaving Bank Rate at 4.5% by year-end.

Markets reacted to today’s news. Sterling weakened to $1.2698, from $1.2720 after the release. Gilts also rallied, with the 10-year yield opening down 6bp at 4.00% from last night’s close and 2-year yields currently 4bp lower at 4.21%.