Inflation figures may shift dynamic in cost of living crisis but rate rise still likely

The headline numbers don’t do justice to the significance of the inflation data.

On the surface, this only looks like a small fall, with the consumer price index (CPI) dropping from 6.8% in July to 6.7% in August.

So what, you might ask? After all, it’s a far smaller drop than the one we heard about last month (July’s 6.8% was significantly down from June’s 7.9%).

The short answer – and this is very important – is that the vast majority of economists had expected inflation to rise in August, not to fall. Indeed, the consensus expectation, the average forecast among economists, was for CPI to climb up to 7%.

There were logical reasons to expect inflation to rise. Fuel prices have been climbing recently following a spike in the value of crude oil. Alcohol duties also increased in August, which was expected to outweigh the forces pulling inflation down: lower food and goods prices elsewhere in the “shopping basket” from which this index is constructed.

So the fact that CPI inflation fell rather than rose is significant.

Indeed, by my reckoning this is the biggest undershoot versus expectations that we’ve seen since the beginning of the cost of living crisis. For months, inflation came in higher than expected. Now it’s come in lower than expected.

At this point you could be forgiven for asking: what’s the point of economists’ predictions when they always get it wrong? And you would have a point.

But at the very least the extent and direction in which they get it wrong gives us a sense of the momentum behind inflation. Indeed, look at core inflation, which strips out volatile items like food and fuel, and the undershoot was greater still: 6.2% versus expectations of 6.8%.

Put it all together and this represents what economists would call a “dovish” moment. It implies, all else equal, that central bankers might be less inclined to impose a further interest rate hike.

Does that mean the Bank of England will pause at its rate-setting meeting tomorrow rather than, as most economists had expected up until this morning, lifting borrowing costs by a further quarter percentage point to 5.5%?

The probability of a pause is certainly higher this morning than yesterday. But given how nervous Threadneedle Street is about inflation and given this is only one month’s worth of data, there’s still a good chance they go ahead with the rate increase anyway.

For the chancellor, the numbers are doubly welcome, because they make it even more likely that inflation will indeed halve this year – in line with one of the government’s five pledges.

For the rest of us, today has provided that rarest of all things in the current era: some good economic news.

Yes, prices are still rising – and fast.

Yes, it’s still much too early to declare an end to the cost of living crisis.

But the dynamic might just have shifted.