Greater-than-expected decline in February inflation boosts market expectations for May rate reduction

The likelihood of the Bank of England reducing interest rates in May has increased following a sharper-than-anticipated drop in inflation last month.

On the same day as the chancellor’s spring statement, the Office for National Statistics (ONS) announced that consumer price inflation eased to 2.8% in February, down from 3% in January. The decline exceeded the City’s forecast of 2.9%, marking a slowdown in price increases despite persistent cost pressures on households from energy and food.

Although inflation remains above the central bank’s 2% target, the possibility of a rate cut in May remains uncertain, particularly as some economists expect inflation to rise again later in the year. However, financial markets have responded to the latest data by raising the probability of a rate cut, with traders now pricing in a 55% chance of the Bank of England lowering its base rate to 4.25% on 8 May.

According to Grant Fitzner, chief economist at the ONS, the primary factor behind February’s decline was a drop in clothing prices, particularly in women’s fashion. This was partially offset by small increases in the cost of alcoholic beverages.

The figures were released just hours before the chancellor’s speech in Parliament, where Rachel Reeves presented a downbeat assessment of the economy and public finances, based on projections from the Office for Budget Responsibility.

The UK economy has struggled to grow in recent months, with high inflation and borrowing costs weighing on consumer and business confidence. Concerns over government tax policies and international trade tensions have further dampened sentiment.

Looking ahead, inflationary pressures are expected to mount again, driven by rising wholesale energy costs and increasing food prices. The Bank of England has warned that inflation could peak at 3.7% later this year, adding to the financial strain on households.

In April, families will face higher council tax, utility bills, and other expenses, while businesses are bracing for the impact of increased employer national insurance contributions. Economic analysts have cautioned that these factors could push inflation close to 4% in the coming months.

Paul Dales, chief UK economist at Capital Economics, suggested that inflation could fall to 2.5% in March, but noted that upcoming increases in utility and water bills could drive it back above 3% in April.

The persistence of elevated inflation is expected to constrain the Bank of England’s ability to cut interest rates, while also keeping government borrowing costs high—posing further challenges for the Treasury.

Core inflation, which excludes food and energy and is closely monitored by policymakers, fell to 3.5% in February from 3.7% in January. Meanwhile, inflation in the services sector remained steady at 5%.

The Bank of England has signalled a cautious approach to rate cuts, with expectations of only two further quarter-point reductions this year. Darren Jones, the chief secretary to the Treasury, emphasised that the government’s priority is maintaining economic stability and supporting working households.