Inflation held steady in August – will interest rates fall tomorrow?

The rate of UK inflation came in at 2.2% in the 12 months to August, marking no change from July.

It comes after the Consumer Prices Index (CPI) fell to the Bank of England’s 2% target in May and June, before rising slightly last month. 

The largest upward contribution came from air fares, which rose this year but fell a year ago. Meanwhile, the largest downward contributions came from motor fuels and restaurant and hotel costs, according to the Office for National Statistics.

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The downward effect of restaurant and hotel costs is perhaps surprising given that Taylor Swift's Eras Tour returned to the UK in August. The tour was blamed for inflation's failure to drop below 2% in June, after services inflation came in high that month.

The Bank of England will announce its next interest rate decision tomorrow, but a rate cut is looking unlikely. The Monetary Policy Committee (MPC) cut rates from their 16-year high on 1 August and is expected to announce one or two further cuts later this year, most likely in November and / or December.

Two areas that may give the MPC cause for concern are core and services inflation, which both rose this month. Core inflation rose from 3.3% to 3.6%, while services inflation rose from 5.2% to 5.6%. 

Both figures give a better idea of the extent to which inflationary pressures are embedded in the domestic economy, as core inflation strips out volatile measures like energy, while the services sector accounts for around 80% of the UK's economic output.

What's more, while the headline rate of inflation is "stable for now... it is expected to tick upwards in the final months of the year," says Alice Haine, personal finance analyst at investment platform Bestinvest. 

She points to the 10% increase in the Ofgem energy price cap, which will cause average household energy bills to rise from 1 October.

We take a closer look at what the latest inflation reading means for the interest rate outlook and your personal finances.

Will the Bank of England cut interest rates tomorrow?

“Traders have been ramping up bets that the BoE will push ahead with a second interest cut this week, though most economists still expect the base rate to remain unchanged at 5%," says Haine. 

The Bank of England has been clear that it will tread a cautious path ahead – and wage growth, services inflation and core inflation are all proving fairly persistent, making a cut seem unlikely. The UK economy stalled in July, showing zero growth for a second month, but it is unlikely to be enough to force the Bank of England's hand.

Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, adds that the MPC may also want to "assess the impact of next month’s Budget before deciding when to loosen policy again". 

Chancellor Rachel Reeves is set to deliver the Budget on 30 October, and prime minister Keir Starmer has warned it will be "painful", leading to fears of tax hikes. It comes after Reeves accused the previous government of leaving a £22 billion shortfall in the public finances. 

In theory, fiscal policy decisions could have an impact on the economic data the Bank of England monitors when setting rates – although the government and the Bank of England are required to operate independently of one another. Labour has been clear that it intends to follow strict fiscal rules to help maintain economic stability, which will come as good news to the MPC.

Despite this, one point of discussion has been the pay rises announced by Reeves in July, when she delivered her spending audit. As part of this, she committed to a pay rise for public sector workers, including a 5.5% rise for school teachers and a 22% rise for junior doctors. 

Critics have suggested this could keep UK wage growth (and by extension inflation) higher for longer, however Bailey dispelled some of these fears when he spoke at the last press conference on 1 August. 

Any impact on inflation would be incremental, Bailey suggested, only getting into “quite small second decimal place numbers”. He cautioned that this was based on “back of the envelope” calculations, but that the MPC would get a fuller picture by 30 October when the Budget is delivered.

What does inflation mean for your personal finances?

The good news is that the rate of UK inflation has slowed significantly from its peak. At the height of the cost-of-living crisis in October 2022, inflation reached 11.1%. At this rate, it would only take around six years for the value of your money to halve.

Despite this, savers should not become complacent now that inflation is back to around 2%. Prices are still rising, just at a slower rate than they once were. What's more, CPI is expected to pick up again later this year. 

If you have savings in the bank, find out what rate you are being paid and make sure it is competitive. The bare minimum is that it should be beating inflation. By shopping around, you can currently find accounts paying roughly 5%. See our round-up of the top savings accounts currently on the market.

Savers should also note that interest rates are expected to fall further later this year, and savings rates will tumble as the base rate comes down. This means you will need to act quickly if you want to secure a good deal. 

If you are able to lock a portion of your savings away for a period of time, you could consider a fixed-rate account. This will pay you a guaranteed rate for an agreed period, while the variable rate on an easy-access account can drop at any time.

While falling rates are bad news for savers, they are good news for mortgage holders. The interest rate outlook has been gradually improving this year as inflation comes under control, and mortgage rates have been coming down as a result. 

Mortgage rates fell in anticipation of the base rate cut in August, and they have come down further since. The average two-year fixed-rate residential mortgage now costs 5.47%, according to Moneyfacts. The average five-year product now costs 5.14%. 

This is significantly lower than last summer, when two-year rates threatened to top 7% and five-year deals came in at almost 6.4%. By shopping around today, homeowners can now secure sub-4% deals.  

Ben Thompson, deputy CEO at Mortgage Advice Bureau, says: "Some mortgage rates are now as low as they were before the infamous mini-budget of 2022, and though these cheap rates are mainly for those with larger deposits, the market is improving across all sectors."

What does inflation mean for investors?

Investors will continue to watch each CPI release with interest, with a recent survey identifying inflation as the biggest risk to portfolios.

Some investments are less sensitive to inflation than others, for example, gold is often heralded as an asset that retains its value well. Equities can also be a good hedge against inflation in some instances, while assets like bonds and cash don’t tend to do so well.

Of course, interest rates (which are closely linked to inflation) are also an important driver of markets. As inflation slows, investors will be expecting these to come down further. 

Some sectors could see a turnaround in their fortunes as the economy shifts, for example, sectors like housebuilding and consumer spending could start to pick up. Meanwhile, "the window of opportunity [for investors] to lock in higher interest rates on cash is starting to close," says Tom Stevenson, investment director at Fidelity International. 

We share further analysis in our recent features: "Where to invest as interest rates fall" and "What do interest rate cuts mean for investors?"