A Third of UK Prices Basket Is in Deflation, Analysis Finds

A third of Britain’s official “shopping basket” has slipped into deflation, providing another green light for the Bank of England to cut interest rates.
The share of items that are cheaper than a year earlier is the highest since the spring of 2021, before pandemic disruptions and Russia’s invasion of Ukraine sent prices soaring, according to Bloomberg analysis of almost 220 goods and services that make up the Consumer Prices Index.
Falling prices for things from cheese and crisps to irons and garden furniture will provide relief to consumers who have seen inflation cool but price levels stay high. That’s helped bring inflation from a peak of over 11% in late 2022 to just below the 2% target, clearing the way for BOE rate setters to lower interest rates again this week.
However, 67 out of the 71 items in deflation in September were in the goods sector of the economy, where the shocks that drove up inflation are now unwinding. Services prices are continuing to rise, fueled by climbing labor costs, one of the reasons why the BOE has cut the cost of borrowing only once this year.
Policymakers meeting this week may be more cautious about speeding up the pace of easing after Chancellor Rachel Reeves’ budget last week unveiled one of the biggest fiscal loosenings in decades. 
The analysis of the UK inflation basket suggests that the cooling in price pressures is at least for now becoming more widespread, welcome news for Prime Minister Keir Starmer’s new Labour government. When adjusted for their importance for spending, the items in deflation accounted for 27% of the basket. The biggest items seeing price falls in terms of their weighting were second-hand cars and electricity.
“Price momentum is slowing, and slowing both meaningfully and broadly,” said Sanjay Raja, chief UK economist at Deutsche Bank, on the findings. “Firms are more reluctant to raise prices across the CPI basket than they were a year or two ago, and this should lead to more ‘normal’ inflation.” He expects a “steady drop in bank rate to less restrictive territory” if positive trends continued.
Rate-setters including Catherine Mann and Megan Greene have been trying to determine the necessary level of goods deflation to offset elevated services inflation.
“You generally tended to see core goods growth of 1%, services price growth of around 3%. It averages out to 2%. If core goods growth is much lower, then actually you could have higher services growth and still have it be target consistent, so we’ve been looking into that a lot,” Greene said in an appearance in Washington last month. 
The BOE reduced bank rate by a quarter point to 5% in August before skipping a move in September, leaving it already lagging behind the US Federal Reserve and European Central Bank. A cut at the Nov. 7 meeting of UK rate-setters is expected, though traders are unsure whether it will be followed up with another reduction in December.
While Governor Andrew Bailey has opened the door to being “a bit more aggressive” with policy, the borrowing splurge at Labour’s first budget is expected to boost inflation. The BOE will give its first indication of whether the new fiscal plans will hinder rate cuts on Thursday, when it also delivers new forecasts. 
Tomasz Wieladek, chief European economist at T. Rowe Price, said the slowdown in inflation is now showing “much more breadth.” However, he cautioned that this may be a temporary factor caused by the impact of plunging energy prices.
“When energy prices come down so significantly, in any competitive market firms would of course pass that savings onto consumers, meaning the price doesn’t rise anymore. But that’s a temporary thing,” he said. “Inflation will be benign for the next couple of months, but it’s hard to know what’s going to happen after that.”
The BOE predicted in August that inflation would pick up later this year, as falls in energy prices last year drop out of the annual comparison. It said this would more clearly reveal the “prevailing persistence” of domestic price pressures in the UK.
However, both headline and services inflation have surprised on the downside. With CPI growth slipping to 1.7% in September, below the 2.1% the BOE had expected, the bank may adjust its forecasts this week, though economists point out that the undershoot is partly due to volatile items such as air fares.
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