Inflation’s down, is an interest rate cut next?

The latest UK inflation figures are in and headline consumer price inflation (CPI) dropped to 2.8% in February from 3% in January, thanks to lower prices for clothing and footwear. It’s a shift in the right direction and away from the relatively flat reading markets were expecting. Core CPI (which excludes volatile items like energy, food, alcohol and tobacco) rose by 3.5% in the year to February, down from 3.7% in January.

Read more: Inflation and investing to beat it

It was a positive start to the day and will likely prompt a few thoughts that the Bank of England (BoE) will now feel more comfortable cutting interest rates, which is normally a boon for stocks. While today’s print won’t hurt the BoE’s gradual rate cut plans, there is still a niggle that makes it all a bit less clear cut.

UK CPI eased to 2.8% in February, with the BoE base rate currently 4.5%.

Source: Office for National Statistics, March 2025.

Services inflation, which measures the prices of everything from haircuts to train tickets to restaurant meals stayed level at 5%. It’s a key measure as around 80% of the UK economy is rooted in services, so we really need to see some downward movement there soon. It’s also a key measure for the BoE, who will need to see the stubborn 5% level soften if the downward trajectory for interest rates is going to gather pace.

The upcoming rise in employer national insurance (NI) contributions and national living wage could put a spanner in the works, given how much staff costs weigh on UK services businesses. It means we’ll need to see wage growth start to moderate more broadly before we’re likely to see services inflation come down. It may be that today’s print reflects employers upping their prices in anticipation of the changes, though - that should become more obvious in the next few monthly readings, which investors will hope to see decline.

Today might have offered a positive surprise but consensus shows the bigger picture isn’t quite as rosy. With water, electricity and household bills set to rise in April, UK pockets will be put under even more pressure. It also means headline inflation will likely get worse before it gets better; the BoE predicts a rise to 3.7% later this year before an about-turn towards the Bank’s 2% target as we move into 2026.

Investors and consumers alike will be hoping the BoE can look through the expected near-term uplift in inflation and continue their path of gradual rate cuts, which tend to kick in with a lag. If that’s the case, a 0.25% interest rate cut in May will look more likely, with optimists pricing in a couple of further cuts before the end of the year. The danger is wage growth doesn’t subside as quickly as hoped and both headline and services inflation stall, keeping rates higher and making the cutting path a shallower one.

One other risk the Bank will be mindful of is the US government’s tariff narrative and how that might impact UK consumers. If the cost of imported goods rises, it could put further pressure on shoppers and businesses, keeping inflation in and around the 3% level or higher.

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