Rising inflation fuels rate-hike fears in UK

Inflation and borrowing in the UK surged beyond expectations in the latest data, heightening concerns about the need for household assistance in the upcoming budget and the probability of a Bank of England interest rate increase. Consumer price inflation climbed to 3.5 percent, up from 3.1 percent in August, according to the Office for National Statistics (ONS).

Economists surveyed by Reuters had predicted a 3.4 percent increase over the past year, as energy prices surged due to the Iran conflict. The Bank of England had previously forecasted a smaller rise to 3 percent in July. Last month's rise, attributed to increased petrol and diesel costs, pushed inflation to its highest since October 2025.

The September inflation rate, used by the government to determine welfare benefit increases, will be pivotal in the finance minister's budget announcement. The government also borrowed more than anticipated, with public debt surpassing £3 trillion, driven by higher debt costs linked to inflation. Finance Minister John Healey, in his first budget, is expected to provide limited aid to households suffering from the energy price surge, constrained by fiscal rules.

Greg Thwaites, interim chief economist at the Resolution Foundation, highlighted the double challenge of addressing cost-of-living pressures while curbing borrowing. Ruth Gregory, deputy chief economist at Capital Economics, anticipates a cautious budget on October 28 with minimal economic impact, pushing fiscal decisions to the following year.

Energy price shock's impact on the broader economy is being closely monitored by the Bank of England. Services price inflation surged to 3.7 percent, outpacing economists' forecasts of 3.6 percent, while excluding volatile categories like food, energy, alcohol, and tobacco, inflation increased to 2.8 percent, surpassing expectations.

The longer inflation remains high, the more likely it is to influence wage and price-setting behavior, increasing risks to waiting for definitive evidence of second-round effects, according to Adam Deasy, an economist at PwC UK. The latest figures also revealed a rise in wage growth, supporting arguments for the first interest rate hike in over three years by the Bank of England.

Governor Andrew Bailey and other policymakers believe the likelihood of a rate increase grows with prolonged high energy prices, although recent impact on inflation has been limited. Megan Greene, who advocates for a rate hike, warned that risks of broader inflation driven by the energy price shock are greater than expected. Investors and analysts expect the Bank of England to raise its benchmark Bank Rate to 4 percent on November 5.