Analysis

The truth about December’s inflation dip to 2.5% - and why it might not last long

“Despite inflation coming down slightly, the message for households is still clear: we’re not out of the woods yet” - Kevin Brown, Scottish Friendly

December’s unexpected dip in inflation is likely to prove short-lived, analysts have warned, though it does increase the chances of a cut in interest rates in the coming weeks.

An under-pressure Chancellor will welcome the news that the annual rate of consumer prices index (CPI) inflation fell to 2.5 per cent last month from 2.6 per cent in November. Most analysts had been expecting the inflation rate to remain unchanged but a fall in hotel prices helped offset a jump in the cost of fuel last month.

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The dip in inflation could pave the way for an interest rate cut as early as February 6, at the next meeting of the Bank of England’s (BoE) rate-setting monetary policy committee. The bank base rate currently stands at 4.75 per cent after two cuts last year. Expectations for a series of further reductions this year have been dampened in the past couple of weeks by turmoil in the bonds market and fresh inflationary concerns.

An under-pressure Chancellor will welcome the news that the annual rate of consumer prices index (CPI) inflation fell to 2.5 per cent last month from 2.6 per cent in November. Most analysts had been expecting the inflation rate to remain unchanged but a fall in hotel prices helped offset a jump in the cost of fuel last month.An under-pressure Chancellor will welcome the news that the annual rate of consumer prices index (CPI) inflation fell to 2.5 per cent last month from 2.6 per cent in November. Most analysts had been expecting the inflation rate to remain unchanged but a fall in hotel prices helped offset a jump in the cost of fuel last month.
An under-pressure Chancellor will welcome the news that the annual rate of consumer prices index (CPI) inflation fell to 2.5 per cent last month from 2.6 per cent in November. Most analysts had been expecting the inflation rate to remain unchanged but a fall in hotel prices helped offset a jump in the cost of fuel last month. | Scotsman/Canva/Barlow

Lale Akoner, global market analyst at investment platform eToro, said: “UK inflation for December came lower than our expectations. Most importantly for the BoE, core CPI fell and services inflation cooled down to the lowest since March 2022.

“This will be a relief for the markets where there has been an unprecedented sell-off in the bond markets, leading to higher interest rates, and subsequent tightening in financial conditions. We continue to expect that a rate cut in February is still odds-on.”

However, others are taking a more cautious stance, with Kevin Brown, savings specialist at Scottish Friendly, the Glasgow-based financial mutual, warning that a February rate cut “still looks fanciful”.

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He said: “While it is positive to see inflation’s worrying bounce-back come to a stop, the essential point here is that it remains too high. Interest rate setters will be reading these numbers with continued unease, as will the government.

Keir Starmer and Rachel Reeves are under pressure over UK’s economic performance (Picture: Oli Scarff)Keir Starmer and Rachel Reeves are under pressure over UK’s economic performance (Picture: Oli Scarff)
Keir Starmer and Rachel Reeves are under pressure over UK’s economic performance (Picture: Oli Scarff) | AFP via Getty Images

“Rate setters will be using these figures as their basis for the first rate decision of 2025 next month. It still appears fanciful that we might get one at the first meeting. There’s a good indication that we won’t be getting rate cuts as quickly as earlier believed, which households are clamouring for, as the monetary policy committee’s number one priority is managing price rises.

“Despite inflation coming down slightly, the message for households is still clear: we’re not out of the woods yet,” Brown added.

Despite last month’s fall in the headline CPI rate, it remains above the central bank’s 2 per cent target level, which has raised concern for economists and policymakers amid stagnant economic growth. The latest figures come during a period of turbulence in the UK financial markets, with the value of the pound dropping sharply and the cost of borrowing rising to decades-high levels over the past week.

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Thomas Pugh, economist at audit, tax and consulting firm RSM UK, warned that the tick down in inflation was likely to be temporary with a 3 per cent rate “in sight”.

December’s unexpected dip in inflation is likely to prove short-lived, analysts have warned, though it does increase the chances of a cut in interest rates in the coming weeks.December’s unexpected dip in inflation is likely to prove short-lived, analysts have warned, though it does increase the chances of a cut in interest rates in the coming weeks.
December’s unexpected dip in inflation is likely to prove short-lived, analysts have warned, though it does increase the chances of a cut in interest rates in the coming weeks.

He said: “December’s dip in inflation won’t last long. The combination of firms passing through the large increase in labour costs imposed by the UK Budget, increases in taxes and rising energy prices means inflation will breach 3 per cent in the spring, forcing [Bank of England] governor Andrew Bailey to pen his first letter to Rachel Reeves. The tick down in inflation in December does raise the chances of a rate cut in February, but rising inflation this year means the Bank of England will cut rates cautiously.”

Sarah Coles, head of personal finance at investment platform Hargreaves Lansdown, described the lower inflation reading as “welcome news” for mortgage borrowers, noting that it could “help suck some of the drama out of the bond markets” and keep a lid on the rise in fixed-rate mortgages.

“If you’re on a fixed rate with plenty of time to run, this will bring some comfort,” she noted. “Rates may rise a little from here, but it could be a relatively short-term shift, and while it’s going to be painful while it lasts, it will ease. The overall direction of the mortgage market in the coming years is still expected to be downwards.

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“If you’re in the market for a remortgage soon, the bad news is that you’re still going to be remortgaging onto a higher rate than your current one. The HL Savings & Resilience Barometer shows that, on average, mortgage holders have £363 left at the end of the month, so those with bigger mortgages could end up in hot water after an expensive remortgage.”

Releasing the latest price data, the Office for National Statistics said a 1.9 per cent decrease in the price of hotels, and a slower increase in prices across restaurants and cafes put the most downward pressure on overall inflation, while the cost of air fares also rose at a much slower rate in December.

This helped services inflation - a metric closely watched by the Bank of England - fall to 4.4 per cent in December, from 5 per cent the month before. On the other hand, petrol and diesel prices increased in December, compared with November.

TUC general secretary Paul Nowak said: “It’s time for the Bank of England to act with another interest rate cut at the start of February. This matters for hard-pressed working people and businesses - more money in people’s pockets means more money spent on our ailing high streets and lower interest rates would make it easier for firms to invest.”

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