A late PS: America’s central bank has voted to leave US interest rate on hold.

Federal Reserve policymakers have agreed unanimously to maintain US interest rates at the current level of 5.25% to 5.5%.

Announcing the decision, the Fed’s FOMC committee say:

Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy.

But, significantly, the Fed also still expects to raise interest rates by a quarter of one percent by the end of the year.

That’s according to the ‘dot plots’, where Fed policymakers estimate where they think rates will be in future.

Here’s a handy Q&A on today’s inflation figures, from PA Media:

Q: What is inflation?

Inflation is the term used to describe rising prices. The inflation rate refers to how quickly prices are going up.

Every month, the Office for National Statistics (ONS) works it out by checking the prices of a range of items in a “basket” of goods and services, including everyday things such as food and train tickets, or larger purchases like a car and a holiday.

If the price of something rises from £10 to £11 over a year, then that would represent annual inflation of 10%.

Q: What is behind last month’s surprise drop in inflation?

The latest dataset from the ONS showed the inflation rate slowed down last month. Analysts had expected it to rise from July’s figure.

Slowing food prices were one of the biggest reasons why the overall rate fell, with the largest falls coming from milk, cheese, eggs, vegetables and fish.

Hotel and accommodation, and air fare inflation also came down significantly last month, which helped to offset rises in other categories such as fuel prices.

Q: Does a fall in inflation mean things are getting cheaper?

Falling inflation does not mean things are getting cheaper, but that prices are rising less quickly than before.

Households are still facing a cost-of-living squeeze, with prices continuing to climb in supermarkets, and important costs such as petrol and diesel going up.

Other products such as alcohol, coffee and clothing also saw price increases accelerate last month.

Q: What does it mean for interest rates?

The latest figures are especially important because they could encourage the Bank of England to stop raising interest rates for a while.

Most economists thought that the Bank’s policymakers would lift rates to 5.5% on Thursday, from the current rate of 5.25%.

But after August’s inflation figure was released, financial market expectations of a rate hike dropped from about 80% to roughly 50%, meaning analysts think it could go either way.

The Bank watches monthly inflation figures closely because they give an indication of whether rate rises are working to slow the economy and bring inflation back down to its 2% target.

Q: What does it mean for mortgages?

If we are nearing the peak of interest rates then it gives some hope for mortgage holders who may be worried about fixing to a new deal.

But the Bank of England is unlikely to bring down interest rates for some time, meaning households will continue to endure more expensive borrowing.

The average five-year fixed residential mortgage was 6.09% on Wednesday, according to data from Moneyfacts.

Q: What is the outlook for inflation from here?

The Government in January pledged to halve inflation from 10.7% to around 5.3% by the end of the year.

Chancellor Jeremy Hunt claimed the latest fall in the CPI rate shows “the plan to deal with inflation is working – plain and simple”.

He added: “But it is still too high which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses.”

The Bank of England thinks that inflation will meet its 2% target by early 2025.

Time for a quick recap.

Investors have been slashing bets on UK interest rates being increased again tomorrow, after a suprise fall in UK inflation.

Britain’s cost of living crisis eased a little last month, with August’s annual inflation rate dropping to 6.7% from 6.8% in July.

Economists had expected a rise, to around 7%, due to rising petrol prices. But instead, the headline rate of inflation fell – as did underlying (or ‘core’) inflation.

Chancellor Jeremy Hunt has hailed the drop as evidence that the government’s plan to halve inflation was on track.

And City investors have been reacting by cutting forecasts for UK interest rates.

Before today, another increase in borrowing costs at noon tomorrow looked to be nailed on. Now it’s more of a coin toss.

Right now, the markets indicate there is a 51% chance that the Bank of England leaves interest rates on hold, for the first time since November 2021, at their current level of 5.25%.

But that leaves a 49% chance that policymakers vote for another rise, taking Bank rate up to 5.5%.

Financial experts are split on what will happen.

Goldman Sachs predicts the BoE will hold rates unchanged, saying:

Combined with their recent dovish commentary, we now expect the MPC to keep Bank Rate unchanged tomorrow and lower our forecast for the terminal policy rate to 5.25% (from 5.5% before).

Sushil Wadhwani, a former Bank of England policymaker, told Radio 4’s Today programme:

I think it makes it less likely that the Bank of England will need to raise interest rates tomorrow.

Berenberg Bank says the decision, due at noon tomorrow, is on a knife-edge.

But another bank, BNP Paribas, predicts the BoE will plump for a ‘dovish’ hike’ – which means raising interest rates, but hinting that they’ve now reached their peak.

The pound fell to a four-month low when the inflation data was released, but has now recovered back to $1.24.

Shares in UK housebuilders have risen, helping to push up the FTSE 100 stock index by almost 1% today.

Today’s UK inflation data now make tomorrow’s Bank of England meeting a close call between a pause and a hike, say analysts at BNP Paribas.

They told clients that the softness in today’s inflation data came as a shock “to us, the market and the BoE” (as we reported back at 6.30am, the markets expected a rise in inflation today).

BNP Paribas predict the Bank will vote to raise borrowing costs, though, saying:

• Today’s soft UK CPI inflation data make tomorrow’s BoE decision a finely balanced one, but we maintain the MPC will err on the side of caution with a ‘dovish’ 25bp hike.

• We think that the MPC will look past some of the weakness in services inflation, as it may be driven by volatility in summer pricing, and wait to be more certain of a more sustained softening in underlying inflationary pressures.

• Risk management considerations would point to the BoE acting tomorrow rather than later.

Goldman Sachs, the Wall Street bank, have cut their forecast for UK interest rate rises for the second time this week.

Goldman now predicts that the Bank of England will leave interest rates on hold at 5.25% at noon on Thursday, having previously expected a rise.

Following the drop in UK inflation this morning, they say:

Combined with their recent dovish commentary, we now expect the MPC to keep Bank Rate unchanged tomorrow and lower our forecast for the terminal policy rate to 5.25% (from 5.5% before).

On Monday, Goldman dropped their forecast that the Bank would raise interest rates at its November meeting, but make one more rate rise tomorrow.

The question of whether the Bank of England raises interest rates tomorrow for a 15th, and likely final, time in a row is “on a knife edge”, says Kallum Pickering, senior economist at Berenberg Bank.

Pickering writes this morning:

By and large, the downside surprise to August inflation is the result of weakening domestic price pressures exceeding the inflationary effect of the rising oil price.

This will be welcome news for policymakers at the Bank of England (BoE) as they deliberate this week whether or not to further raise the bank rate from 5.25% in order to add even more downward pressure to domestic demand and thus prices. The BoE decision will be announced at 12:00 (BST) tomorrow.

The market for overnight index swaps (OIS), which had dramatically cut its bets for the peak bank rate in recent weeks (from a high of 6.5% in early July - which we had pushed back against), has now lowered its bet on a further final 25bp hike to a c50% chance from a virtually certainty yesterday.

Although inflation is now falling, it remains high – and “the real damage has largely been done”, points out Alfie Stirling, chief economist at the Joseph Rowntree Foundation.

Sterling says:

For 7.3 million low-income households, the costs of essential goods and services have reached a level that is literally unaffordable. For those already skipping meals and going without hot water, the rate at which prices continue to rise is now secondary.

He adds that people are “increasingly being squeezed from all sides”:

Not only is the price of money itself rising rapidly – in the form of interest on credit cards, loans and overdrafts – but this is slowing wider spending in the economy too, increasing the risk of lost work and earnings.

“Government can and should be doing much more to protect living standards for those on the lowest incomes. This starts with following the existing rules and raising benefits at least in line with inflation. And poverty charities, national health organisations and the wider public now all agree that the next step is a new guarantee that as a minimum benefits must always cover the cost of essentials.”

Small businesses are also hoping that the Bank of England’s policymakers could resist raising interest rates for the 15th time in a row tomorrow.

Martin McTague, national chairman of the Federation of Small Businesses (FSB) says:

“It’s fair to say small firms will be relieved there wasn’t a rise in inflation, as some had predicted, but this result is far from the substantial fall they were hoping for.

“With signs that interest rate rises are starting to bite, tomorrow’s base rate decision by the Bank of England has to be the peak for rates, one way or another.

“Leaving rates high for longer than needed will devastate the chances of an economic recovery.

“Small firms are living with the effects of inflation that has been far higher than the target for many months now, so today’s inflation results aren’t enough alone to remove their worries about the economic situation, especially given the fall in GDP (gross domestic product) announced last week.”

McTague adds that around one in ten small businesses say they are at least at moderate risk of insolvency, so the government should produce measures to support them in the upcoming autumn statement.

That should including overhauling business rates, and extending the current discount for retail, hospitality and leisure businesses beyond next April, the FSB says.

The financial markets have slashed their chances of another increase in UK interest rate at noon on Thursday, following the drop in UK inflation to 6.7% in August.

1pm UPDATE: The money markets indicate that a quarter-point rise in UK interest rates tomorrow (from their current level of 5.25%, to 5.5%) is now less than a 50% chance, down from around 80% yesterday afternoon.

The odds of no-change have risen from around 20% to 45% around 55% at 1pm today.

As this post shows, the market-implied peak of UK interest rates has dropped, with investors no longer certain that rates will hit 5.5%.

The yield, or interest rate, on UK government bonds is also falling this morning, as investors cut their forecasts for how high UK interest rates will rise.

That could be a boost to people looking to remortgage in the coming months, as the yield on two-year UK bonds is used to price those home loans.

Nick Rees, foreign exchange market analyst at Monex Europe, argues that the Bank of England will not be dissuaded from hiking interest rates again tomorrow, despite today’s drop in inflation.

Rees says the shock deceleration in UK inflation is good news for the BoE, but suspects its policymakers will want to be sure this is not just a one off fluke.

Also, they want to see a sustained slowdown in wage growth before calling an end to policy tightening.

Rees says:

Whilst we believe today’s latest round of inflation data likely comes too late to change many minds on Threadneedle Street, the slowdown in price growth is likely to set tongues wagging over the prospects of a hold in rates tomorrow.

Indeed, headline CPI growth dropped to 6.7% YoY in August, down from 6.8% last month, despite consensus expectations having looked for an increase in the measure in this latest release.

More crucially, underlying inflationary pressures softened even faster, putting the end of policy tightening in the UK front and centre for markets.

Given the still elevated pace of wage growth and the fact that underlying inflation pressures have only just started to break lower, we expect that the BoE will still choose to raise rates tomorrow lunchtime, though risks to this view are now clearly skewed to the downside.

But if the Bank does raise rates again, from 5.25% to 5.5%, that could well be the last increase in the current cycle, Rees adds.

Sushil Wadhwani, a prominent economist and former Bank of England policymaker, has predicted that UK interest rates are less likely to rise tomorrow.

Speaking on Radio 4’s Today programme, Wadhwani points out that the components which caused today’s downward surprise in inflation, such as hotel prices, are volatile.

But even so, today’s inflation data is “good news”, Wadhwani says:

I think it makes it less likely that the Bank of England will need to raise interest rates tomorrow.

The Bank last time told us that there were three things that they were looking at. They were looking at whether the labour market was loosening. They were looking at what would happen to services inflation, and they would look at wages.

Now two out of those three things have gone favourably in the sense that the labour market has loosened more than they thought, services today came in below their forecast [it slowed from 7.4% to 6.8%.]

However, wages are still growing “rather faster” than the Bank expected (total earnings in the three months to July 2023 were 8.5% higher than in the same period a year earlier – the highest since modern records began in 2001).

But even so, Wadhwani says he would be “thinking very seriously” about pausing interest rate rises tomorrow, if he were still a member of the Bank’s Monetary Policy Committee.

Today’s surprise fall in the UK’s inflation rate to 6.7% in August will strengthen the case that interest rates are at or near peak, says the Resolution Foundation.

They point out that today’s latest inflation data is well below the Bank’s forecast that inflation would rise to 7.1% in August.

That is “payback” for the BoE, after several months of disappointing data coming in higher than expected.

While inflation is still uncomfortably high in Britain – and higher than any other G7 economy – the latest data suggests that it is heading in the right direction at least, Resolution say.

James Smith, research director at the Resolution Foundation, explains:

“After months of disappointing data, the Bank of England has finally received some ‘inflation karma’ as price pressures eased considerably in August.

“This will strengthen the case that the Bank’s fourteen consecutive interest rate rises are now showing clear signs of putting downward pressure on inflation, and that its rate-rising cycle will soon end.

“But while mortgagors will welcome the end of interest rate rises, Britain’s wider cost-of-living crunch is likely to continue well into the coming election year.

Jeremy Hunt has hailed this morning’s drop in inflation as a sign that the government’s economic strategy is delivering results.

The chancellor says:

“Today’s news shows the plan to deal with inflation is working – plain and simple.

“But it is still too high which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses.

“It is also the only path to sustainably higher growth.”

That plan has included a reluctance to accept inflation-beating public sector pay rises, prompting today’s joint strike by consultants and junior doctors.

But shadow chancellor Rachel Reeves points out that the UK is forecast to have the highest inflation of any major economy this year (see earlier post), adding:

“The Prime Minister is too weak to turn things around, while his predecessor Liz Truss continues to call for the same policies that crashed the economy this time last year.

“The Conservatives have wreaked havoc and working people are paying the price.”

The pound has dropped to its lowest level in almost four months, following August’s welcome drop in inflation.

Sterling has shed half a cent against the US dollar to hit $1.2335, the lowest since late May.

Traders are calculating that the surprise drop in the CPI rate eases some of the pressure on the Bank of England to keep raising interest rates.

Thursday’s BoE meeting might bring the final increase in borrowing costs in the current rate-hike cycle.

Ipek Ozkardeskaya, senior analyst at Swissquote Bank, says:

British inflation unexpectedly eased from 6.8% to 6.7% in August, and core inflation fell from 6.9% to 6.2%.

The surprise fall in UK inflation triggered a kneejerk selloff in sterling, as today’s data cements the expectation that the Bank of England’s (BoE) next rate hike could also be its last.

In another boost to the UK economy, core inflation has fallen.

The rate of core CPI, which strips out energy, food, alcohol and tobacco, rose by 6.2% in the 12 months to August 2023. That’s a sharp fall on July, when core CPI was 6.9%.

Core inflation is an important measure for central bankers, as they try to assess how high to raise interest rates to squeeze out inflationary pressures.

Newsflash: UK inflation has unexpectedly fallen in August, as the cost of living pressures on households continued to ease.

The Consumer Prices Index, which tracks annual price changes, has fallen to 6.7% in August, down from July’s 6.8%.

That’s lower than the expectations of City economists, who forecast a rise to 7%, and comes despite the chancellor’s fears of a ‘blip’ higher.

This could ease some of the pressure on the Bank of England to raise interest rates again, tomorrow.

But, this still leaves inflation over three times above the UK’s target of 2%.

More to follow…

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

The UK’s battle against the rising cost of living may suffer a reversal today, when the latest inflation data is released.

The UK Consumer Prices Index for August, due at 7am BST, is expected to rise for the first time in six months.

Prices are forecast to have risen by 7% in the year to August, up from July’s 6.8%.

As this chart from last month shows, CPI inflation had been dropping back from its peak over 11% last autumn.

These declines had bolstered the chances that the government hit its target of halving inflation this year.

But earlier this month, chancellor Jeremy Hunt warned we could see a “blip” higher in inflation this month, as average fuel prices have jumped back above £1.50 a litre.

Oil has climbed to its highest level this year, with Brent crude rising $95 per barrel on Tuesday, adding to inflation pressures globally.

Economists have also warned that a rise in alcohol duty at the start of this month could have pushed up prices of wine, and most spirits (although some low-strength drinks became cheaper).

But food price inflation is expected to ease further in August, having slowed in July from the decades-high levels hit earlier in the year. Data provider Kantar has recently reported that UK grocery inflation slowed to its lowest in a year.

A rise in inflation today could put the seal on another UK interest rate rise. The Bank of England will announce tomorrow whether it has raised interest rates for the 15th time in a row, as it continues to battle inflation.

Another central bank, America’s Federal Reserve, will announce its own decision on interest rates tonight. The Fed is expected to leave US interest rates on hold, while it assesses the impact of its earlier rate rises.

The agenda

• 7am BST: UK inflation report for August

• 9.30am BST: UK house price and rental indices for July

• 12pm BST: US weekly mortgage applications

• 7pm BST: US Federal Reserve interest rate decision

• 7.30pm BST: US Federal Reserve press conference