What now for interest rates as school fees push UK inflation to 10-month high of 3%?

All bets are off when it comes to interest rate cuts after a rebound in inflation and concerns it could spike further as fresh pricing pressures feed through this spring.

Bank of England policymakers now face a challenging few months as they attempt to fend off those inflationary concerns while avoiding any harm to a lacklustre economy. It comes after the annual rate of inflation jumped to its highest level for ten months in January, as air fares, rising bread and meat prices and a sharp jump in private school fees all contributed to higher living costs.

The consumer prices index (CPI) measure of inflation rose to an annualised 3 per cent in January from 2.5 per cent in December, according to the Office for National Statistics (ONS). That was higher than the 2.8 per cent forecast by most analysts and puts CPI a full percentage point above the Bank of England’s 2 per cent target rate for inflation. However, it remains well off October 2022’s peak of 11.1 per cent.

Fresh inflationary pressures will add to the money worries facing millions of people.

The rebound in inflation will add to pressure on policymakers as they ponder further interest rate cuts. Earlier this month, the central bank’s monetary policy committee (MPC) voted for a quarter-point reduction to take the base rate to 4.5 per cent after similar cuts in August and November last year. It took interest rates to their lowest point since June 2023.

However, individuals and businesses are facing a barrage of inflationary pressures including changes announced in the autumn Budget that are due to kick in from April, higher energy costs and rising council and water charges. There are also concerns around any potential fallout from the introduction of trade tariffs.

Inflation is expected to steadily rise over the coming months, with the Bank of England itself predicting that CPI will peak at 3.7 per cent in late summer. Economists have therefore indicated that higher-than-expected inflation and rising wage costs could cause the central bank to pause rate cut plans, adding to the misery for millions of borrowers and mortgage holders.

There are also concerns the UK could enter a period of stagflation - where there is sticky inflation and muted economic growth.

Andrew Bailey, governor of the Bank of England, which is facing a trick balancing act over interest rates amid sticky inflation and weak economic growth.

Nicholas Hyett, investment manager at Wealth Club, said there was “little chance” of further rate cuts any time soon, with the next MPC meeting scheduled for March 20.

“If there was any doubt about what the Bank of England would do at its March interest rate meeting there isn’t now. Headline inflation has jumped significantly, and came in some way ahead of market expectations,” he added.

“Making matters worse is the substantial uptick in core inflation - which strips out food and energy prices and is considered a better measure of domestically generated inflation. With core inflation nearly twice the Bank of England’s target we see little chance the bank starts cutting rates again any time soon.”

Others remain more optimistic over near-term cuts in rates, with Rob Morgan, chief investment analyst at Charles Stanley, expecting a further quarter-point reduction by May.

“Many households and businesses will be hoping for significantly lower interest rates to reduce borrowing costs,” he noted. “Owing to the uncertain trajectory of inflation the best they can hope for is a slow and steady downward trend, but there is a good chance market expectations will shift to more than a couple of cuts for 2025 which could provide a bit of relief in coming months.

“Meanwhile, the interest rate picture remains positive for savers with the best easy access rates still north of 4.5 per cent. However, this inflation-beating rate of return is likely to narrow over time as the base rate moves lower. It may therefore be a good time to consider a fixed rate if you are happy to lock your money away because inflation and interest rate expectations may now fall back a little.”

The price of meat and bread both increased by 2.3 per cent year-on-year, according to the latest ONS data. Inflation was also pushed higher by rising private school costs, following the Labour government’s move to apply 20 per cent VAT to private school education and boarding fees.

The data showed that many schools passed on significant price increases to parents as a result, with private school fees up 12.7 per cent year-on-year. The education sector as a whole saw inflation at 7.5 per cent as a result - the highest rate since September 2015.

Higher national insurance contributions for employers and the increase in the minimum wage, which were announced in last October's Budget, will come into force in April and are expected to contribute to higher inflation.

Janet Mui, head of market analysis at wealth firm RBC Brewin Dolphin, said: “It is hard to justify a rate cut in March when services CPI is 5 per cent and wage growth is 6 per cent year on year, while GDP and employment data have been better than thought as of late. The policy direction will be driven by the monetary policy committee’s judgement between averting growth risks versus containing inflation.

“For now, the priority is inflation. But things may change throughout the year as business surveys are overwhelmingly negative. Market reaction is relatively muted and bond traders continue to price in about two more rate cuts by the end of 2025.”

The next three MPC meetings are due to take place on March 20, May 8 and June 19.

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