Bank of England Fights Inflation

Britain Grapples with Stubborn Inflation as Price Rises Halt Their Descent

The United Kingdom's struggle with high living costs persists as new figures show inflation held steady for a third consecutive month. For the twelve months leading to September, the annual rate of price increases was 3.8%, defying expectations of a further rise. This figure, released by the ONS, the Office for National Statistics, keeps the rate of inflation significantly higher than the 2% objective set by the Bank of England. While the halt in the upward trend offers a sliver of relief, the underlying data points to a complex economic picture, presenting a serious challenge for both households and policymakers.

For months, climbing prices have squeezed family budgets across the country. The latest data indicates that while the relentless surge may have paused, the pressure is far from over. This persistent inflation complicates the next steps on borrowing costs for the Bank of England and places further scrutiny on the government's forthcoming budget. The stability of the inflation measure, while avoiding a worse outcome, underscores the deep-seated nature of the current economic challenges. It signals that the path back to normality will likely be a long and arduous one for the British economy.

The Inflation Calculation Explained

Understanding inflation begins with monitoring the cost of common items and services. A "basket" containing a multitude of products, from a loaf of bread to a cinema ticket, is compiled by the ONS to measure the average change in costs over time. This method, which produces the headline inflation figure through the Consumer Prices Index or CPI, is a key economic barometer. For instance, if a carton of milk that cost £1 sees its price climb to £1.05 twelve months later, that item’s inflation is 5%. The overall CPI figure represents the average increase across the entire collection.

To keep the basket relevant, its contents are updated annually to reflect modern consumer habits. In a recent update, yoga mats along with virtual reality headsets were added, while adverts in local newspapers were removed. This ensures the index accurately captures the spending patterns of the typical UK household. By monitoring the value of this collection over a 12-month period, the ONS provides a comprehensive snapshot of how living expenses are changing, a vital indicator for economic planning and policy decisions.

A Stubbornly High Rate

September's CPI figure of 3.8% matched the rates recorded for August and July, marking the highest sustained level since the 4% seen in January 2024. While this is a significant drop from the 40-year peak of 11.1% that was reached in October of 2022, it remains a serious concern. The Bank of England also monitors "core inflation," which strips out volatile elements such as energy and food costs to get a clearer view of underlying price pressures. Core CPI eased slightly to 3.5% in September from 3.6% in August, offering a small sign of cooling in the economy.

The persistence of elevated inflation is a complex issue. The initial surge in 2022 was driven by a sharp rise in global energy prices, exacerbated by Russia's invasion of Ukraine and strong post-pandemic demand. More recently, high food costs have been a key factor keeping the rate elevated. A fall in the inflation measure does not signal that overall costs are declining; it simply means they are increasing at a slower pace. Household budgets continue to feel the strain of accumulated price hikes over the past few years.

Drivers of Current Price Pressures

Several factors are currently contributing to the UK's elevated rate of inflation. A notable upward pressure in the latest figures came from transport costs, particularly airfares along with petrol, which saw a year-on-year increase. These rises were partially offset by a fall in prices for recreation and culture, including live music events. The inflation rate for food and non-alcoholic drinks, a major concern for households, eased slightly but remains high. Economists point to government-mandated hikes in the national insurance payments and minimum pay as costs that supermarkets may be passing on to consumers.

Beyond these immediate pressures, structural issues within the UK economy contribute to the problem. Weak productivity growth combined with wage increases that outpace output can create a cycle where businesses pass on higher labour costs to customers. This dynamic risks embedding inflation, making it a persistent feature of the economy rather than a temporary shock. Such structural weaknesses present a long-term challenge that monetary policy alone cannot easily solve.

The Bank of England's Dilemma

To combat soaring inflation, the Bank of England had previously lifted borrowing costs to a peak unseen in 16 years, at 5.25%. The principle is straightforward: making it more costly to borrow money reduces spending power for both individuals and businesses, which in turn cools demand and decelerates price growth. However, this is a delicate balancing act. High borrowing costs can stifle economic growth, leading to job losses and reduced investment. Homeowners with mortgages face higher monthly repayments, and businesses may postpone expansion plans.

More recently, with the economy flatlining and the labour market showing signs of softening, the Bank has shifted its approach. Starting in August 2024, it has enacted five separate interest rate reductions, which brought the base rate to its current level of 4%. This strategy aims to stimulate spending and investment to boost economic growth, despite inflation remaining substantially over the 2% goal. The Bank's Monetary Policy Committee is now navigating a narrow path, trying to support the economy without letting inflation become permanently entrenched.

Future Path of Interest Rates

The decision by the Bank of England to hold interest rates at 4% during its September gathering was widely anticipated. Governor Andrew Bailey has repeatedly stressed that the fight against inflation is not over and that any reductions to the rate in the future would be implemented in a careful and gradual manner. The Bank's own forecasts from August suggested inflation would hit a maximum of 4% during September before declining. The actual figure of 3.8% was slightly better than predicted but still provides little room for aggressive easing of monetary policy.

Market expectations for another rate cut at the November meeting have become less certain. The decision will be heavily influenced by the upcoming Autumn Budget, which is scheduled for November 26. Any significant tax or spending announcements could alter the economic outlook and, consequently, the Bank's calculations. Furthermore, global economic uncertainties, including the fallout from American trade tariffs and geopolitical conflicts, add another layer of complexity to the decision-making process, forcing a cautious approach from policymakers on Threadneedle Street.

Wages and the Labour Market

The relationship between wages and inflation is a critical component of the economic puzzle. The latest data reveals that regular pay across Great Britain climbed by 4.7% for the three-month period ending in August, outpacing the rate of inflation. After accounting for price rises, real wages advanced by 0.9% over this period. This provides some relief to workers whose purchasing power had been eroded by the crisis around living expenses. Public sector pay saw a significant annual growth of 6%, compared to 4.6% for private industry.

However, the broader labour market is showing signs of cooling. The rate of unemployment edged up to 4.8% for the three months leading to August, its highest level since mid-2021. The number of job vacancies has also been falling consistently for over three years, indicating a slowdown in hiring activity. This softening of employment conditions is a central element in the considerations of the Bank of England, as it suggests that inflationary pressures from the labour market may be starting to ease, potentially giving more scope for future interest rate cuts.

A Global Perspective on Inflation

The challenge of controlling inflation is not unique to the United Kingdom. Both the United States and countries within the Eurozone have been contending with similar pressures. In the Eurozone, the inflation figure for nations sharing the euro was 2.2% during September, a slight increase from August's 2%. The ECB, or European Central Bank, started to reduce its main interest rate in June of 2024, and after several reductions, its primary rate has been at 2% since June 2025, reflecting a different stage in the inflation cycle compared to the UK.

In the US, inflation moved up to 2.9% during August, remaining above the 2% objective of the central bank. In a significant move in September, the Federal Reserve lowered its primary lending rate for the first time since December of 2024, placing it between 4% and 4.25%. This decision was driven by growing concerns about a weakening job market, which were seen to outweigh the risks of above-target inflation. This divergence in policy highlights the different economic conditions and priorities facing central bankers across the major Western economies.

Economic Growth Outlook

The UK economy has shown some resilience, with GDP growing by 0.9% in the first half of 2025, slightly ahead of forecasts. This performance was stronger than that of the Euro Area and the US during the identical timeframe. However, the outlook for the remainder of the year and into 2026 is more subdued. Forecasters expect economic growth to slow, hampered by ongoing global uncertainty, elevated borrowing costs, and weak consumer confidence. Projections for full-year growth in 2025 hover around 1.3%, with modest expansion predicted over the medium term.

Business investment has been a relative bright spot, showing growth in the first part of the year. Yet, this growth is projected to level off as companies contend with a weaker economic outlook and the increased cost of capital. Household consumption remains soft, with families choosing to put more money aside when confronted with economic uncertainty. This cautious behaviour from both businesses and consumers suggests that the UK economy is navigating a period of fragility, with the risk of a slowdown weighing on policy decisions.

The Chancellor's Challenge

The persistent level of inflation presents a significant challenge for the chancellor, Rachel Reeves, ahead of the Autumn Budget. The government has stated its commitment to supporting the Bank of England in its work to bring inflation down. Policies presented in the budget will be closely scrutinised for their potential impact on prices. Traditionally, the September inflation figure is used to determine the uprating of various benefits and state pensions, as well as increases in duties on alcohol and tobacco.

However, the "triple lock" on state pensions means the increase will be determined by the higher wage growth figure of 4.8%. Decisions on other benefits and duties will be a key test of the government's fiscal strategy. There is pressure to provide support for households still struggling with high living expenses, but also a need to avoid fiscal measures that could fuel further inflation. The chancellor must balance these competing demands while trying to foster economic stability and growth in a difficult environment.

Food Prices and Consumer Impact

For many households, the most tangible effect of inflation has been at the supermarket checkout. The rate of food inflation hit alarming levels in 2023 and has been a primary driver of the high headline figure. While the yearly rate of inflation for non-alcoholic drinks and food eased to 4.5% for the twelve months ending in September, this follows a period of exceptionally steep increases. The expense of a weekly grocery run remains significantly higher than it was two years ago, placing a considerable burden on low-income families in particular.

Industry experts have warned that food-related inflation may remain elevated into 2026. Factors such as labour costs, energy prices, and the impact of global supply chain disruptions continue to affect the value of items on the shelves. The British Retail Consortium has highlighted that inflationary pressures from the last budget are still filtering through the supply chain. This suggests that consumers may not see significant relief in their grocery bills in the immediate future, maintaining pressure on household finances.

The Housing Market's Role

The interest rate choices made by the Bank of England have a direct and significant impact on the housing market. The series of rate hikes up to August 2023 led to a sharp increase in mortgage costs, which cooled the property market and put pressure on homeowners. The subsequent cuts have offered some respite, but borrowing costs remain much higher than the historic lows seen before the inflationary surge. This has affected housing affordability and transaction volumes across the UK.

Renters have also faced steep price increases, with rental expenses climbing at a historic rate in many parts of the country. These housing costs are a major component of household expenditure and contribute to the overall pressures on living standards. As the Bank of England weighs its next steps, the potential impact on the housing market will be a key consideration. Striking a balance between controlling inflation and maintaining stability in the property market is another facet of the complex challenge facing policymakers.

International Trade and Geopolitics

The UK's economic outlook is intrinsically linked to global events. The uncertain fallout from American trade tariffs, particularly following the return of Donald Trump to the White House, has created unease for British exporters. Changes in US policy can have ripple effects on global trade flows and commodity prices, which in turn affect UK inflation. The British Chambers of Commerce has noted that while there have been some positive trade developments, the overall global outlook remains fraught with risk.

Furthermore, geopolitical conflicts, such as the tensions in the Middle East, can have a direct impact on energy prices. As a net importer of energy, the UK is vulnerable to volatility in worldwide markets for gas and oil. A spike in energy costs could quickly translate into higher inflation, complicating the efforts of the Bank of England to return to its 2% objective. These external factors are largely outside the control of domestic policymakers but must be factored into their economic forecasts and decisions.

Productivity and Long-Term Health

A persistent issue plaguing the UK economy is its weak productivity growth. Productivity, which measures the output per hour worked, is a key determinant of long-term economic prosperity and rising living standards. When productivity is stagnant, wage increases are more likely to fuel inflation rather than reflect genuine economic growth. This structural weakness makes the UK more susceptible to inflationary pressures compared to some of its international peers.

Addressing the UK's productivity puzzle is a long-term challenge that calls for a diverse strategy, including investment in infrastructure, skills, and technology. While the monetary policy from the Bank of England can manage the immediate symptoms of inflation, it cannot solve these deeper structural problems. Sustained, non-inflationary growth will depend on policies that successfully boost the productive capacity of the British economy, a task that falls to the government and will likely be a central theme of economic debate for years to come.

The Path Ahead

The UK economy stands at a crossroads. Inflation has proven to be a difficult challenge, and while the extreme peaks of 2022 are behind us, the journey back to the 2% objective is slow and uneven. The central bank needs to maintain its careful navigation between taming price pressures and nurturing a fragile economy. The coming months will be crucial, with the Autumn Budget and subsequent decisions on borrowing costs set to shape the economic landscape into 2026.

For households and businesses, the period of uncertainty is not yet over. While wage growth has provided some cushion, high living expenses continue to bite. The slowdown in the labour market and the subdued growth forecast suggest that challenges remain. The resilience of the UK economy will be tested as it confronts both domestic structural issues and a volatile global environment. The key to a stable future lies in carefully calibrated policy that fosters sustainable growth while ensuring inflation is brought firmly under control.