UK inflation unexpectedly eased to 2.5% in December, down from 2.6% in November, according to the Office for National Statistics (ONS). This deceleration in price growth, fueled by lower hotel and tobacco costs, has ignited speculation of potential interest rate cuts by the Bank of England (BoE) in the coming months.
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December’s Inflation Deceleration: Key Drivers
Several factors contributed to December’s inflation slowdown. Falling hotel prices, coupled with more moderate price increases in restaurants and cafes, played a significant role. Additionally, a slower rise in tobacco prices, influenced by the November 2023 tobacco duty increase, contributed to the overall decline. Clothing and footwear inflation also eased. However, these downward pressures were partially offset by rising fuel and second-hand car costs, which experienced their first annual growth since July 2023.
Market Reaction and Interest Rate Cut Probabilities
Economists had projected inflation to remain stable at 2.6% in December. The unexpected dip to 2.5% triggered a surge in market expectations for an interest rate cut at the BoE’s February meeting. Financial markets now price in a 74% probability of a rate reduction, up from 62% prior to the inflation data release. This probability briefly peaked at 81% in the immediate aftermath of the announcement.
Core Inflation and Services Inflation Also Decline
Core inflation, which excludes volatile food and energy prices, also fell more than anticipated, decreasing to 3.2% from 3.5%. Analysts had predicted a more modest decline to 3.4%. Services inflation similarly outperformed expectations, dropping to 4.4% in December from 5% in November, significantly below the forecasted 4.8%.
Food Prices and Other Notable Trends
Food prices, a substantial component of the inflation basket, continued their upward trajectory, rising by 2% in the year to December. However, this increase matched the previous month’s rate. Within the food category, bread, cereals, and certain beverages experienced slower price growth or remained stable compared to the previous year. Airfares, while still rising, saw a significant moderation in their monthly increase, climbing 16.2% between November and December, compared to a 57.1% surge a year earlier.
Government Response and Economic Outlook
Chancellor Rachel Reeves acknowledged the ongoing cost-of-living challenges faced by families and highlighted government actions to mitigate these pressures. These measures include protecting wages from higher taxes, freezing fuel duty, and increasing the national minimum wage. Reeves emphasized economic growth as the top priority for improving living standards across the UK. However, the latest inflation figures arrive amid concerns about the UK’s public finances, with rising government borrowing costs and a weakening pound sterling against the dollar. These economic headwinds have drawn criticism of Reeves’ economic management and recent tax increases. While inflation has cooled down, it remains above the BoE’s 2% target.
Expert Commentary and Future Expectations
Ed Monk, associate director at Fidelity International, welcomed the December inflation dip as a positive sign, suggesting it could pave the way for anticipated interest rate cuts later this year. While market expectations for rate cuts have fluctuated recently, the latest inflation data reinforces the likelihood of two rate reductions in 2024. Despite the positive development, the long-term trajectory of inflation and the BoE’s monetary policy response remain subject to ongoing economic data and evolving market conditions.
