The UK's inflation rate climbed to 3.5% in the year leading up to September, marking the highest level in nearly a year and surpassing the Bank of England's 2% target. This increase, slightly higher than economists anticipated, was primarily driven by rising petrol and diesel prices. The Office for National Statistics (ONS) tracks the prices of hundreds of everyday items to calculate inflation, which influences the Bank of England's decisions on interest rates.
The current base interest rate stands at 3.75%. Raising rates makes borrowing more expensive, which can reduce spending and slow price increases. However, higher borrowing costs also pose risks to the economy, including higher mortgage repayments for homeowners and reduced business investment and job creation.
While the current inflation rate of 3.5% is below the peak of 11.1% in October 2022, prices have not decreased; they have simply risen at a slower pace. The recent increase was largely due to a 29.8% rise in motor fuel prices compared to the previous year. Food price inflation remained steady at 1.3%, but disruptions caused by the war in Iran could lead to further price increases.
Energy prices have significantly impacted UK inflation, particularly after the Covid pandemic and Russia's invasion of Ukraine. The Bank of England has warned that disruptions in global energy markets could push inflation as high as 6% in the worst-case scenario. Prime Minister Andy Burnham's decision to scrap VAT on household electricity bills in October is expected to have a small downward impact on inflation.
The Bank of England has cut interest rates six times between August 2024 and June 2026, bringing them down to 3.75%. However, energy price volatility has made it more likely that interest rates will rise. Wages in the UK have grown ahead of inflation, with regular pay increasing by 0.8% between June and August after accounting for inflation.
In Europe and the US, inflation rates have also been a challenge. The eurozone's inflation rate was 3.8% in September, up from 3.2% in August, while the US inflation rate was 3.7% in September, up from 3.4% in August. Both the European Central Bank and the Federal Reserve have raised interest rates in response to these trends.