UK inflation data opens door to rate cut down the line

UK inflation data remained in line with expectations in August. Headline prices remained at 2.2% YOY, there was an uptick in core price growth to 3.6% and service price inflation rose from 5.2% to 5.6%. 

This is not as hawkish as it first seems. The jump in service price growth was largely down to base effects and rising airfares over the peak summer holiday season. This was especially evident in European routes, where prices rose by 22.2% between July and August, the largest monthly rise since 2001. If you thought that your summer trip was costlier this time, you were right. 

However, within today’s data there were some positive signs that service price growth could moderate going forward. For example, some of the largest downward contributions to the service price index came from restaurants and hotels. 

One of the main themes in financial markets over the summer was the decline in the oil price, and motor fuels fell 3.4% compared to a year ago. The oil price has remained volatile in September so there could be further downward pressure on the UK’s headline inflation in the coming months.  

What does this mean for the BoE? 

This report doesn’t change the picture for tomorrow’s BOE meeting, where we expect the bank to hold UK interest rates. We will be watching to see what the statement and minutes say about the UK’s growth outlook. 

If they sound concerned about the UK’s faltering growth outlook, then we think the market may ramp up the chances of a 50bp rate cut in November, especially if the Fed cuts by 50bps tonight. There is currently 32bps of rate cuts priced in by the market for the BOE’s November meeting. As we mentioned, the jump in service price growth is not as worrying as it first seems, so rising service price growth is not a threat to the overall inflation picture, which may placate some of the hawks at the BOE.

Watch BoE’s assessment on the UK’s growth outlook

In the aftermath of the inflation report, interest rate expectations for the UK have barely budged. There has been a reduction in expectations of a rate cut at tomorrow’s meeting, which have fallen to 15% from 24% yesterday. However, the market is still expecting approx. 50bps of rate cuts by the end of this year. How the BOE addresses the UK’s slowing growth rate in tomorrow’s statement has the potential to move UK asset markets and that is worth watching closely.

Ahead today is the Fed meeting. This is the main event for financial markets as it’s expected to be the start of the Fed’s much anticipated rate cutting cycle. Whether it’s 25 or a 50bp cut, if it’s perceived as a dovish or a hawkish cut could determine what happens to financial asset prices for the rest of this year. There is currently a 61% chance of a 50bp cut, according to the CME’s Fedwatch tool.

Can Microsoft reignite the AI trade?

Elsewhere, Microsoft and Blackrock have announced a new joint fund to invest in AI infrastructure. It will have $30bn to spend. Will this chunk of change be enough to give the AI trade another lease of life? Nvidia has been volatile recently and fell another 1.2% on Tuesday. Its share price is down more than 5% this month, as investors have cooled on the AI darlings. The news of the AI investment fund comes after Microsoft announced a boost to its dividend and a $60bn share buyback programme on Tuesday. Microsoft is laying the sweeteners on thick to entice investors back to AI. 

If you want to reignite the AI trade, then why not have the biggest players use the cash piles they have amassed through the AI trading boom of the last two years to reinvest in AI infrastructure and keep the whole cycle going. Obviously more details are needed to see where the fund will invest, but ultimately the success of the AI trade will depend on its uptake in everyday life and across the global economy. 

The market open: What to expect  

Stocks in Europe could edge lower at the open, although the S&P 500 is set to open slightly higher. The UK inflation data could also weigh on UK stock indices, as it virtually rules out a dovish surprise rate cut from the BOE tomorrow. Overall, we expect markets to be quiet as we wait for this evening’s Fed meeting.

In the G10 FX space, GBP/USD is worth watching closely. It has jumped on the back of the CPI report, and it may attempt to test $1.32. However, this is stiff resistance. If the pound can break through this level vs. the USD, it would be a bullish development that could open the door to $1.35.