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Rachel Reeves has been boosted by a sharp drop in inflation as she seeks to find £40bn of tax hikes and spending cuts in this month’s Budget.
The chancellor will welcome the dip, which saw inflation fall under the Bank of England’s 2 per cent target for the first time in more than three years, as she prepares for what promises to be a brutal Budget.
The consumer price index (CPI) dropped to 1.7 per cent, down from 2.2. per cent in August, according to the Office for National Statistics.
The news came as it emerged the Treasury had identified a £40bn funding gap which Ms Reeves will seek to plug to protect key departments from real-terms cuts and put the economy on a firmer footing.
Plugging an earlier £22bn black hole in the public finances highlighted by ministers would be enough only to “keep public services standing still”, Ms Reeves told the cabinet on Tuesday. It follows a recent promise from the chancellor that there would be “no return to austerity under this government”.
Inflation fell below analysts’ expectations, with experts pencilling in a more modest drop to 1.9 per cent.
The fall raises the chances the Bank of England will cut interest rates again in November to 4.75 per cent in a further boost to the chancellor.
The Bank’s governor Andrew Bailey had previously indicated a desire to bring interest down, saying earlier this month that rate cuts could become “more aggressive” if needed.
Responding to the inflation data, chief Treasury secretary Darren Jones said: “There is still more to do to protect working people, which is why we are focused on bringing back growth and restoring economic stability to deliver on the promise of change.”
But his Tory opposite number Laura Trott hit back, saying: “Today’s figures show Labour inherited a strong economy, thanks to the difficult decisions we took to tackle inflation when it was at its peak.”
September’s inflation figure is used by the government to decide a number of tax and spending changes for next year, and means UK state benefits will rise by just 1.7 per cent next year.
Meanwhile the state pension will rise by more than double that amount due to the triple-lock, jumping by 4.1 per cent.
ONS chief economist Grant Fitzner said: “Lower airfares and petrol prices were the biggest driver for this month’s fall.
“These were partially offset by increases for food and non-alcoholic drinks, the first time that food price inflation has strengthened since early last year.
“Meanwhile the cost of raw materials for businesses fell again, driven by lower crude oil prices.”
Rampant inflation in previous years has caused everyday costs to spiral, with CPI hitting a record 11.1 per cent in October 2022. The latest figure marks a return to more usual inflation, but still remains higher than rates in early 2021, which were often below 1 per cent.
David Murray, financial planning expert at abrdn said: “All signs were pointing to a decline in inflation in September, so to see rates continue a downward trend to 1.7 per cent – the first time inflation has been below the Government’s 2 per cent target in more than three years – will be a huge relief.
“This will leave many hoping for a cut to interest rates next month, meaning we’d see two cuts before the end of the year, with some even suggesting that the base rate will be brought down to 4.5 per cent.”
The unexpected interest rate cut has seen the value of the pound fall slightly, down half a cent against the US dollar today. However, it was revealed yesterday that wages are still taking a positive turn, rising 4.9 per cent in the three months to August.
The Chief Secretary to the Treasury, Darren Jones, said: “It will be welcome news for millions of families that inflation is below 2 per cent.
“However, there is still more to do to protect working people, which is why we are focused on bringing back growth and restoring economic stability to deliver on the promise of change.”
Suren Thiru, Economics Director at ICAEW, said: “These figures provide reassurance that the UK has moved into a more moderate inflation environment, aided by lower fuel prices.
“September’s decline could be reversed this month, given the rise in energy bills following the increase in Ofgem’s energy price cap, which is likely to pull the headline rate back above the Bank of England’s 2 per cent target.
“The notable drop in services inflation suggests that underlying price pressures are becoming less sticky. The squeeze from slower economic activity and weaker wage growth should help keep it on a downward trajectory.
“Though the stars are aligning for a November rate cut, the upcoming Budget is the final hurdle as rate setters will want to assess the inflationary impact of any measures announced before loosening policy again.”
Chancellor Rachel Reeves will be announcing Labour’s Budget on 30 October. It’s likely the party will be buoyed by the fall in interest rates, having set a central mission of economic growth.