Inflation Expectations Drop at UK Businesses, Validating Bank of England's Peak Rate Calls

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Inflation expectations at UK businesses have turned meaningfully lower according to a regular survey conducted by the Bank of England and the University of Nottingham.

The Bank's monthly Decision Maker Panel (DMP) survey found one year ahead CPI inflation expectations amongst UK finance chiefs decreased to 4.8% in August, down from 5.4% in July.

The survey of Chief Financial Officers from small, medium and large companies across the UK also found year-ahead output price inflation was expected to be 4.9% in the three months to August, down from 5.2% in the three months to July.

The survey is closely watched by the Bank of England's Monetary Policy Committee (MPC) and will boost expectations that the Bank is close to ending its rate hiking cycle amidst expectations that inflation will fall sharply into year-end.

The MPC is particularly worried about a wage-price spiral keeping inflation elevated for a long period of time in which workers demand more pay and businesses react by raising prices.

If inflation expectations amongst businesses and workers are pointed lower then the odds of such a cycle evolving are greatly reduced.

The DMP survey revealed that realised output price inflation remained at 7.4% in the three months to August. The single-month data for August was also 7.4%, 0.4 percentage points lower than in July.

Current CPI perceptions of firms were 7.8% in August (down from 8.4% in July).

Annual CPI inflation fell from 7.9% to 6.8% in the latest ONS release on 16 August, during the DMP survey window.

The findings come a day after Bank of England Governor Andrew Bailey told Parliament's Treasury Select Committee the Bank was close to a point where it could pause the interest rate hiking cycle. The comments prompted a retreat in UK bond yields and the British Pound

The DMP survey findings will back Bailey's suggestion that inflation will continue to fall at a steady clip over the coming months, justifying an impending pause in the hiking cycle.

The market remains fully priced for a September interest rate hike of 25 basis points, but Bailey's comments and the DMP survey findings put a question mark over another rate hike in November.

"The moderation in the BoE Decision Makers Panel CPI assumptions has further dragged on terminal rate expectations. We remain of the view that rates will peak at 5.50%, terminal rates have come in around 8bps since yesterday. However, as terminal rates currently remain at 5.62% there remains scope for moderation, dragging on GBP valuations," says Jeremy Stretch, an analyst at CIBC Capital Markets.

The Bank has communicated it is prepared to hold interest rates at elevated levels for an extended period as it recognises inflation will likely only fall back to the 2.0% target by as late as 2025.