UK inflation stabilised at 3.8% in August, matching the Monetary Policy Committee’s (MPC) already hawkish forecast, as higher food prices were offset by falling airfares. However, we still expect inflation to reach 4% in September. This will make it difficult, but not impossible, for the MPC to cut interest rates again this year. We maintain our view that the next rate cut will likely come in February at the earliest when inflation is closer to 3%. We still expect interest rates to settle at 3.5% next year, but the pace at which we get there may be a little slower than we first thought.

What’s driving UK inflation?

Headline inflation held steady at 3.8% in the latest figures, with several factors pulling in different directions.

Accommodation services inflation jumped from 0.7% to 2.3%, as Oasis concerts likely helped to support prices and push up inflation. What’s more, fuel inflation also rose to -4.9% from -6.7%. Here, a small 0.4% m/m gain was boosted by favourable base effects from last year falling out of the annual comparison. This added 5bps to the headline measure.

Food and drink inflation rose to 5.1%, which is its highest rate since January 2024, because agricultural commodity prices continue to push inflation up globally. However, food inflation has been stronger in the UK than elsewhere recently. This is potentially because retailers are also passing through higher employment costs to consumers. In any case, we expect higher wholesale prices to push this measure closer to 6% by the end of the year.

On the downside, airfares inflation unwound from a huge surge in July, which reflected the timing of school holidays, and knocked 10bps off inflation. This helped to keep a lid on the headline inflation rate and drag services inflation down to 4.7%.

Has UK inflation peaked?

We expect inflation to peak at 4% in September as rising food prices continue to put upwards pressure on the measure. Fuel inflation will again push up the headline rate because favourable base effects are now dropping out of the annual comparisons.

Looking further ahead, we think inflation will spend the rest of the year at around 3.5–4%, before falling to a little under 3% in April next year. This is when some of those punchy one-off increases in taxes and regulated prices start to fall out of the annual comparisons.

That said, there’s a few reasons why we think the risks are skewed towards inflation persisting further.

First, inflation will hit 4% in September and stay close to that level for the rest of the year. Given that 4% is the critical threshold where households pay more attention to inflation, this raises the risk of households bargaining for bigger pay rises to protect their real incomes, which could push inflation up.

Second, the labour market looks like it’s starting to stabilise, albeit at a weak level. Given that pay growth is still running well above the 3% level that’s needed to return inflation to 2%, a recovery in the jobs market may mean there is not enough slack to bring pay growth down to a sustainable level.

On the other hand, we think the next Autumn Budget poses risks in both directions. Chancellor Rachel Reeves needs to raise around £20bn in taxes in November. Near-term tax rises would prove contractionary, dampening demand and weighing on inflationary pressures. However, were the Chancellor to opt for another round of stagflationary tax rises, such as VAT and duty hikes, then that could prevent inflation from falling back below 3% in April.

For now, we expect inflation to peak at 4%, or perhaps slightly higher, in September before dropping sharply and closer to target early next year.

What are the chances of an interest rate cut in 2025?

Despite inflation matching the MPC’s forecast and services inflation marginally undershooting it, we don’t think this will make much difference to the MPC’s decision to hold interest rates for now. With inflation heading to 4%, steady, but not stellar, growth, and signs of a stabilising labour market, we think the MPC will choose to focus on reducing inflation from almost double its target.

Ultimately, we think further interest rate cuts have been postponed rather than cancelled. We expect another rate cut in February when inflation will be closer to 3% and back on a downward path. That said, we still think a contractionary fiscal event like the Autumn Budget could give the MPC enough cover for a cut in December.

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