UK inflation unexpectedly slowed to 2.5 per cent in December, easing pressure on chancellor Rachel Reeves and clearing the path for the Bank of England to press ahead with cutting interest rates next month.
The consumer price inflation figure, which was below November’s 2.6 per cent reading and pulled lower by restaurant and hotel prices, triggered the biggest one-day rally in gilts in more than a year. Analysts had expected inflation to hold steady last month.
Wednesday’s data will provide some relief for Reeves, who is contending with higher borrowing costs fuelled by fears the UK economy could be entering a period of stagflation, in which sluggish growth is accompanied by persistent price pressures.
But economists still expect inflation to reaccelerate in the months ahead, particularly given that December’s drop was driven by volatile factors such as lower airfares.
“There is still work to be done to help families across the country with the cost of living,” said Reeves on Wednesday, as she insisted she would “fight every day” to deliver growth and improve living standards.
The recent increase in UK government borrowing costs, which last week hit a 16-year high, has threatened to blow a hole in the chancellor’s promise to balance day-to-day spending with tax receipts by 2029.
But Wednesday’s UK inflation data sparked a rally in gilts, which strengthened after a lower than expected US core inflation reading later in the day. The 10-year gilt yield was down 0.16 percentage points in afternoon trading at 4.73 per cent, putting the bonds on track for their best day since late 2023.
The pound was up 0.5 per cent on the day at $1.228, regaining some of the ground lost this year.
Prime Minister Sir Keir Starmer on Wednesday said Reeves would remain chancellor for “many years” and that Labour this year would hold only one Budget, which is when the UK government typically announces tax changes.
“The chancellor will be in place for many, many years to come,” he told MPs at Prime Minister’s Questions. “We’ll have one Budget, that’s what we’re committed to, strong fiscal rules, and we’ll stick to them.”
Zara Nokes, an analyst at JPMorgan Asset Management, said: “After a difficult start to the year, this morning’s inflation print will provide some relief to chancellor Reeves.”
She added that a stronger inflation figure could have been “a catalyst for further volatility in the gilt market”.
The report, from the Office for National Statistics, comes as the BoE’s Monetary Policy Committee prepares to hold its first meeting of 2025 next month.
Following the data, traders were pricing in a more than 80 per cent chance of a quarter-point cut in February, compared with about 60 per cent beforehand, according to levels implied by swaps markets.
Rob Wood, UK economist at Pantheon Macroeconomics, said the below-consensus inflation figure gave the BoE a “window of opportunity to cut rates in February”.
However, he described the figure as a “temporary reprieve”, adding that the steep drop in airfares was likely to reverse in January.
Wednesday’s data showed that services inflation, which is closely watched by the BoE as a gauge of underlying price pressures, slowed sharply to 4.4 per cent from 5 per cent previously.
It was also below the 4.9 per cent reading expected by economists.
About half of the drop in services inflation was driven by airfares, according to Ruth Gregory of Capital Economics. Airfares growth was the third-weakest for a December on record.
This was partly because the ONS collected airfare data around December 10, before the usual boost to prices driven by the school holidays, and looked at flights returning on Christmas Eve and New Year’s Eve, which tend to be cheaper than the surrounding days.
Core inflation, which excludes food and energy, dropped to 3.2 per cent from 3.5 per cent.
The figures come as Reeves is under increasing pressure over the impact of decisions she made in October’s Budget, including increasing employer national insurance contributions.
On Tuesday, the chancellor shrugged off calls for her resignation, after her Conservative counterpart, Mel Stride, accused her of being part of a “Shakespearean tragedy” amid the turmoil in bond markets.
Stride welcomed the inflation figure on Wednesday but warned there were “still challenges ahead”, with the employer national insurance rise “yet to bite” and likely to lead to higher prices.
Liberal Democrat Treasury spokesperson Daisy Cooper said the unexpected fall in inflation offered “a glimmer of hope, but the reality is the UK economy remains stuck in the mud”.
Growth was “nowhere to be found”, she added, after the government’s “damaging” increase to employer national insurance.
Treasury chief secretary Darren Jones argued on Wednesday that the pressure on Reeves over tumult in the markets was “unfair”, telling LBC that many issues were down to “global movements in international markets” and noting that other countries were facing similar challenges.
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