UK inflation unexpectedly fell in December, raising expectations that the Bank of England could reduce interest rates in the coming months.
Prices rose by 2.5% in the year to December, down slightly from 2.6% in November. This marks the first decline in inflation in three months, offering a glimmer of relief amid rising living costs. The drop was primarily driven by a fall in hotel prices and smaller-than-usual increases in airfares. Despite this improvement, prices continue to rise faster than the Bank of England’s target of 2%.
The latest figures are seen as a boost for Chancellor Rachel Reeves, who has faced mounting criticism due to the fall in the pound’s value and government borrowing costs reaching their highest levels in years.
“If it stays like this, we will be on route to slightly more interest rate cuts,” Michael Saunders, a former member of the Bank of England’s monetary policy committee, told the BBC.
Last month, the Bank of England opted to keep interest rates at 4.75% after the UK economy posted no growth between October and December. However, the latest inflation data strengthens the case for a potential reduction to 4.5% in February, according to Ruth Gregory, deputy chief UK economist at Capital Economics.
Increased investor optimism has led to growing bets on an interest rate cut next month, with many also anticipating further reductions by the end of 2025.
Easing price pressures in sectors such as restaurants and hotels helped pull inflation down in December. The Office for National Statistics (ONS) also reported a slower rise in tobacco product prices. However, the positive trends were partially offset by the rising cost of fuel and second-hand cars.
Grant Fitzner, chief economist at the ONS, noted that despite the overall drop in inflation, rising fuel prices and more expensive cars were contributing factors that limited the decline.
Following the release of the inflation figures, UK government borrowing costs fell to their previous week’s levels, and the pound strengthened slightly to $1.22. Debt costs in the UK further eased after US inflation figures showed a larger-than-expected drop in core inflation, despite the headline inflation figure rising.
Chancellor Reeves acknowledged that there was “still work to be done” to help families with the cost of living but pointed to the government’s actions, including protecting workers’ wages from higher taxes and increasing the minimum wage.
However, Shadow Chancellor Mel Stride criticized the government’s economic management, accusing it of stifling growth and calling for Reeves to explain how she plans to address the country’s economic challenges.
