UK Inflation Holds at 3.8% in September as Markets Price Earlier BoE Cuts

UK CPI at 3.8%: Forecast Miss Sparks Gilts Rally and Sterling Dip

The UK inflation rate held at 3.8% in September, surprising forecasters who expected a return to 4.0% and reinforcing the narrative that price pressures are stabilising. Services inflation, a key focus for the Bank of England, also held at 4.7%, undershooting consensus. Markets reacted quickly: gilts rallied as traders raised the probability of a 2025 BoE rate cut by December, while sterling eased against the dollar and euro.

What the ONS Data Show

The ONS confirmed headline CPI at 3.8% y/y for a third consecutive month; on a month-on-month basis, the index was flat. Food and non-alcoholic beverages continued to cool, while some travel and recreation categories softened. The print leaves inflation almost double the BoE’s 2% target, but counters the Bank’s own guidance that September could nudge back to 4%.

Policy Read-Through: BoE Optionality Widens

Investors quickly pulled forward easing expectations. Interest-rate swaps assigned materially higher odds to a December reduction (with some probability shading into November), reflecting confidence that underlying momentum is ebbing despite sticky services. While the MPC has warned on persistence, today’s release gives policymakers more room to pivot if subsequent labour-market and inflation prints cooperate, and if November’s budget signals credible fiscal restraint.

Market Moves at a Glance

• Gilts: Short-end yields declined as traders priced a higher likelihood of near-term cuts.
• FX: GBP slipped after the softer-than-forecast CPI, consistent with a market pulling forward BoE easing.
• Rates Path: Pricing now leans toward one cut into year-end, with the curve implying further easing through 2026, data permitting.

Why the Forecast Miss Matters

The BoE had guided that headline CPI might peak near 4% around September before gradually drifting lower toward target by mid-2027. Landing at 3.8% instead bolsters the view that disinflation is back on track, even if the last mile remains challenging. Relative to peers, the UK still runs the highest inflation in the G7, but the direction of travel, especially in goods and selected services, offers tentative relief for households and the Treasury.

Inside the Basket: What’s Cooling, What Isn’t

• Cooling: Food inflation moderated; selected recreation/culture categories (including events/tickets) eased; producer-price signals point to stable factory-gate costs, aiding goods disinflation.
• Sticky: Services inflation at 4.7% remains above levels consistent with a quick return to target, reflecting wage dynamics and domestic cost pass-through.

Fiscal Overlay: Reeves’ November Budget in Focus

Chancellor Rachel Reeves signalled cost-of-living relief measures in the November Budget. Markets will parse whether support is paired with offsetting fiscal tightening to avoid re-stoking demand at a delicate point in the disinflation path. Any credible consolidation could complement BoE easing by lowering the economy’s underlying inflation impulse.

Risks to the Disinflation Narrative

• Services/Wages: Elevated pay growth could keep services inflation sticky, complicating MPC timing.
• Energy & Regulated Prices: Shocks in utility bills or administered prices could interrupt the glide-path.
• Global Backdrop: Renewed trade frictions or supply disruptions would push against progress, while a sharp sterling depreciation could import price pressure. (Risk framing informed by BoE commentary and recent coverage.)

What to Watch Next

1. Labour-market data: Vacancies, wage growth and participation, key to the services inflation outlook.
2. BoE communications: Whether guidance acknowledges improved inflation dynamics while retaining a data-dependent stance.
3. November Budget: The mix of relief and consolidation; gilt supply and OBR projections for 2026–27.
4. CPI Trimmed/Services Measures: Confirmation that core pressures are decelerating into Q4.

Bottom Line

UK inflation holds at 3.8% in September, undercutting 4.0% forecasts and nudging markets to price earlier BoE cuts. The print doesn’t close the book on persistence, services at 4.7% remain a hurdle, but it strengthens the case that disinflation is re-establishing itself. For policymakers, this creates optionality; for markets, it validates a softer rates path, contingent on forthcoming data and the Budget’s fiscal tone.