In the last two weeks, the 10-year gilt yield has fallen by about 30bp from 4.75% to 4.4% and financial markets have gone from pricing in less than a 25% chance of another rate cut by the end of the year to a two-thirds chance now. So, what’s changed? Will we get an early Christmas present from the Bank of England (BoE) and what does it mean for the Autumn Budget?

Recall that the BoE has been on a pretty consistent once-a-quarter rate cutting path for the last 18 months or so. However, stubbornly strong wage growth, sticky inflation, the upcoming Budget and a clear shift on the Monetary Policy Committee (MPC) from worrying about the labour market to worrying about inflation meant the MPC seemed likely to diverge from this path and keep rates on hold through to at least April. Until recently anyway.

What’s changed the MPC’s thinking on interest rate cuts?

Two major factors have shifted the rate cut outlook.

First, inflation came in significantly below expectations. Rather than peaking at 4% in September, as widely expected, it came in at 3.8%. That might not sound like much, but it’s a big miss in the world of inflation predictions.

It also means inflation has now been stable at 3.8% for three months and should start to fall back from here. This will help to settle some anxiety on the MPC about the upward trend in inflation.

What’s more, a big driver of September’s undershoot was a drop in food-price inflation. This is especially important for the BoE because evidence shows that food price inflation plays an outsized role in setting household inflation expectations.

If people and businesses anticipate inflation to be 4% in the future, rather than 2%, then they’re more likely to bake higher inflation into their wage and price-setting behaviour. Food prices are the most visible part of most people’s spending. For example, you’re far more likely to notice that the price of the beef mince you buy every week is up 25% y/y than that your home insurance is down 8% y/y, at least according to the ONS. (My insurance isn’t, so maybe this will be the next statistic to be revised.) Sharply lower food-price inflation reduces the chances that inflation gets ’stuck‘ at 4%.

Second, recent rumours coming out of the Treasury suggest it’s determined to avoid another counterproductive policy-induced surge in inflation next year. Reinforcing this view are the latest rumours that VAT will be cut on energy bills and that income tax increases are back on the table. That means inflation should drop back to below 3% from the spring onwards, providing the MPC with a much more accommodating inflation profile to lower interest rates than repeating last year’s Budget would.

Will the MPC wait and see until after the Autumn Budget?

This probably isn’t enough to prompt the MPC into cutting interest rates next week. If it was sticking to its quarterly rate cutting path, then this would be the next chance. After all, at 3.8%, inflation is still almost double the MPC’s 2% target. It will also want to see what is actually in the next Autumn Budget before committing to further rate cuts.

Our hunch is still that the next rate cut likely won’t come until February because the MPC will want to let inflation come down a little further. But, the door to a December rate cut is now wide open, especially if the Budget focuses on deflationary tax rises (like income tax increases) and shies away from levers that would boost inflation (employers’ NICs, VAT, duties etc).

All this is undoubtedly good news for Rachel Reeves because it will lower the government’s borrowing costs. It will also go some way to lowering corporate borrowing costs and mortgage rates. Unfortunately for the Chancellor, the fall in gilt yields has probably come too late to be incorporated into the OBR forecasts. That’s because to forecast the government’s borrowing costs, the OBR uses yields in a window of 10 working days some time before the Budget. That window was possibly earlier this month and before most of the recent fall in gilt yields.

Overall, we have grown more confident in the last few weeks that the disinflationary trend is intact and further interest rate cuts are on the way. But, a huge amount is riding on the Autumn Budget. A sensible approach that focuses on deflationary tax rises – and even some spending cuts – and is credible could firmly put inflation and rates on a downward path. A repeat of last year’s stagflationary Budget, though, would see inflation and rates remain high, but more on that next week.

Housing market and consumer credit still subdued

On Wednesday, we expect money and credit data to show consumer credit growth slowing slightly to £1.5bn from £1.7bn, which would be in line with September’s poor survey data.

The good news is that retail sales grew strongly in September and surveys for October suggest consumers shook off the initial tax-hike speculation, meaning we may be in for a positive surprise.

On the housing front, we expect a drop in mortgage approvals to 64k in September, down from 64.7k in August. The housing market has struggled to recover from April’s stamp-duty hike, with measures of house prices slowing markedly since the start of the year.

Confirming that view, we expect Nationwide’s house price index, released on Friday, to show house-price growth stabilising at 2.2% y/y, down markedly from the 4.1% y/y growth we saw at the start of the year.

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