UK inflation unexpectedly declined in December, increasing the likelihood of an interest rate cut next month. Consumer prices rose by 2.5% in the year to December, down slightly from 2.6% in November and below economists’ expectations of 2.6%.
This marks the first decline in inflation in three months and provides some relief for the Chancellor, who has been under pressure due to a weaker pound and elevated government borrowing costs, which recently reached multi-year highs.
The Office for National Statistics (ONS) attributed the slowdown to easing price increases in restaurants and falling hotel prices. On a monthly basis, inflation rose by 0.3%, below the forecasted 0.4% but above the 0.1% increase seen in November.
Following the release of the data, UK borrowing costs dropped to last week’s levels, with 10-year bond yields falling by approximately 20 basis points. The pound strengthened slightly to around $1.22, while the FTSE 100 index gained over 1%.
CORE INFLATION
Core inflation, which excludes volatile energy and food prices, fell to 3.2% year-on-year in December, marking a four-year low. This was down from 3.5% in November and below the expected 3.4%. Meanwhile, services inflation dropped sharply to 4.4%, its lowest level in two years, from 5% in the previous month. These declines indicate that price pressures are easing across key sectors of the economy.
While the 0.1% drop in the annual inflation rate might seem modest, it holds significant implications for monetary policy. The broader downward trend in inflation is likely to influence the Bank of England’s (BoE) decision-making process. With GDP figures set to be released tomorrow, market sentiment now suggests an over 80% probability of a 25-basis-point interest rate cut in February.
GLOBAL CONTEXT
In contrast, U.S. inflation data showed headline inflation climbing for the third consecutive month to 2.9% year-on-year in December, in line with expectations. The monthly increase, however, exceeded forecasts at 0.4% compared to the anticipated 0.3%. Core inflation in the U.S. showed signs of easing, with the annual rate falling to 3.2% and the monthly rate cooling to 0.2%.
Oil prices reacted positively, rising by over 2% to approach $80 per barrel. This increase was driven by softer U.S. core inflation data, which reinforced expectations of Federal Reserve rate cuts, potentially boosting economic activity and oil demand.
OUTLOOK
The latest UK inflation figures highlight a welcome moderation in price pressures, potentially signaling a turning point for the economy.
With interest rate decisions looming and global economic trends in flux, all eyes are now on upcoming GDP data to provide further clarity on the UK’s economic trajectory.
INDUSTRY REACTION
John Phillips, Chief Executive of Just Mortgages and Spicerhaart, says: “News of a slight drop in inflation is certainly a surprise and contradicts the expectations of the markets and many analysts.
“This will no doubt be welcome news for ministers – not least the Chancellor who faces considerable pressure as uncertainty rips through the UK financial markets.
“How likely the UK is able to sustain this slowing in inflation is still up for debate, especially given the fallout from the recent Budget and the implications for businesses, as well as the growing prospect of US tariffs days away from Trump’s inauguration. All have had an impact on market expectations with rising gilt yields and government borrowing costs.
“The Bank of England stands at a crossroads between managing sticky inflation and supporting economic growth.”
“The Bank of England stands at a crossroads between managing sticky inflation and supporting economic growth.”
“The latter cannot be understated given growing fears of stagflation. A slight reprieve or not, will a surprise slowing of inflation encourage the central bank to act faster than perhaps many are expecting – giving hope to those wanting to see further movement on interest rates.
“Either way, a remedy is clearly needed to help kickstart economic growth. In our world, we have seen a really positive start to the new year with high levels of buyer registrations and mortgage enquiries. If the MPC is able to respond to this positive news at its first meeting next month, that will certainly help sustain this.”
SURPRISE DIP
David Hollingworth, associate director at L&C Mortgages, says: “The surprise dip in inflation is some positive news for borrowers who will have been unsettled by the recent unrest in the gilt markets and what it may mean for mortgage rates.
“Although there may still be increases to come in the months ahead, the fall in inflation will firm up the hopes that the Monetary Policy Committee will cut the base rate in February.
“Three members voted in favour of a cut in December, but the market has been less convinced that the Bank of England will cut rates as far and as quickly as had previously been expected.
“That has seen fixed rates edging higher before the end of the year, something that’s continued into the new year.
“This will have added an unwelcome dollop of uncertainty for borrowers that had been hoping for continued improvement in mortgage rates. The base rate is still expected to fall but the question is whether that drop will now be shallower and more gradual.
“Yesterday’s figures will help to maintain some stability in mortgage rates but those borrowers coming to the end of their current deal are still likely to want to secure a new rate a few months ahead of time. That will allow them to dodge any further increases if fixed rates continue to rise but still gives them room to review if things take a turn for the better.”
SIGHS OF RELIEF
Peter Stimson, Head of Product at the mortgage lender MPowered Mortgages, says: “Downing Street has been resounding to sighs of relief from Number 11 yesterday morning. The improvement in the headline rate of CPI was modest, but its psychological value is amplified by the fact it was unexpected.
“More positive still is the bigger fall in core inflation, which strips out volatile factors like energy and food costs, from 3.5% down to 3.2%.
“Nevertheless CPI is still well above the Bank of England’s 2% target, and provided tomorrow’s GDP figures aren’t horrendous, no-one should expect the Bank to bring forward its next Base Rate cut to February.
“Even with today’s progress on CPI, the Bank is walking a tight rope between the need to leave interest rates high to tame inflation and the desire to cut them to kickstart the flatlining economy.
“THE MORTGAGE MARKETS HAVE NOW PRICED IN JUST TWO CUTS TO THE BASE RATE IN 2025, WITH AT LEAST ONE LIKELY TO BE AT THE END OF THE YEAR”
“For now, there are bigger fish to fry. Swap rates, the main driver of fixed rate mortgage pricing, have been rising in recent weeks. The reasons are complex and varied, but the worry about persistent inflation is a key driver – how the markets react to this morning’s news will be key.
“While yesterday’s inflation figures are welcome, on the mortgage interest rate front things could still get worse before they get better.”
MARKET FLUX
Simon Webb, managing director of capital markets and finance at LiveMore, adds: “The industry – not to mention Rachel Reeves – will welcome yesterday’s surprising news of a drop in headline inflation in December.
“At 2.5% it’s closer to the Bank’s 2% sweet spot which it touched on for a moment in September last year. The markets are, however, in some flux, so the drop in inflation doesn’t necessarily equate to a drop in the Bank Rate come February.
“Many consumers will still be struggling with higher energy bills, which are likely to push the headline inflation rate higher over the coming months until it drops off in the second half of 2025.
“The good news for people aged 50 to 90 years plus – who might ordinarily have very limited mortgage options especially in these conditions – is that on the market today there is a much wider range of products developed specifically for them including standard, retirement and equity release options to help with areas such as debt consolidation and to provide drawdown facilities if that’s right for them.”
FAR FROM ROSY
Alice Haine, Personal Finance Analyst at Bestinvest by Evelyn Partners, says: “The outlook for inflation from here is far from rosy. Rising oil prices, which hit a six-month high on Tuesday following recent US sanctions on Russian oil, are raising fresh inflation worries, while the weaker pound is also an aggravating factor because it makes imports more expensive.
“The inflation picture is likely to worsen from April 1 when Reeve’s hike in employer national insurance rates and the minimum wage take effect.
“Businesses are widely expected to offset rising employee costs by passing them on to consumers by hiking prices, as well as suppressing wage increases. All eyes will now be pinned on Thursday’s GDP data, to see if the slowing growth in the second half of 2024 continued in November.”
