What do inflation figures mean for the budget and interest rates?

For the chancellor, the latest inflation figures were unbridled good news in advance of her inaugural budget on October 30. On several fronts, she can credibly claim that they will fortify the public finances.
For starters, September’s inflation rate — 1.7 per cent, well below the Bank of England’s 2 per cent target — is used to determine the increase in working age benefits payments next April. The figure was below expectations, trimming the welfare bill.
Rachel Reeves may yield, however, to those who have pointed out that, under the triple-lock, pensions are set to rise by more than twice as much as welfare payments. She could lift benefit payments by 2.5 per cent as a compromise.
• UK inflation rate falls below target to 1.7%
Second, inflation is falling quicker than the Bank of England had expected. Threadneedle Street had thought that the rate would slip to 2.1 per cent in September. Crucially, services inflation, which underpins ratesetters’ thinking, fell to 4.9 per cent, well below the Bank’s forecast of 5.5 per cent.
City analysts reckon that a rate cut is nailed on at the Bank’s next meeting on November 7 and that the chances of this being followed by another quarter-point drop in December has intensified. Rates were lowered for the first time in four years in August and stand at 5 per cent.
Rob Wood, chief UK economist at Pantheon Macroeconomics, a consultancy, said: “A 25 basis-point November rate cut is a racing certainty, and either a consecutive cut in December or a 50 basis-point reduction in November looks like a much better bet.”
Expectations among investors for a quicker rate-cutting cycle would lead the Office for Budget Responsibility (OBR) to provide the chancellor with greater scope to scale back tax rises or spending cuts.
The OBR judges how much money the government must allocate to interest payments by using the “market curve” — an average of investors’ expectations for the trajectory of interest rates in the coming years. If this curve steps down, so does the debt interest bill, provided that the government does not let borrowing get way out of hand.
Reeves told a cabinet meeting on Tuesday that measures announced at the budget could amount to £40 billion, larger than the £22 billion “fiscal black hole” we’ve heard so much about.
Government spending, which exceeded forecasts this year under the Conservatives largely thanks to elevated expenditure on the asylum system, could also be restrained by weaker price growth. Civil servants may demand lower wage settlements as cost of living pressures recede. The price of running the government’s day-to-day activities could also ease.
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On the other hand, the boost to the public finances from “fiscal drag”, where workers are thrown up the tax ladder when they receive a pay rise because thresholds are frozen, will not bring in as much if inflation remains lower than projected.
Taxes will rise at the budget, the chancellor has made that clear, and these inflation numbers won’t change that.
However, a step up in public investment, as Reeves has signalled will happen, should expand the UK’s capacity to make goods and services which, in the long-run, can boost growth and shield against inflation.