Slower UK inflation relieves pressure on Rachel Reeves as financial markets calm

A surprise dip in UK inflation last month has provided some reprieve for Rachel Reeves, as financial markets calmed following a recent period of volatility.

The cost of Government borrowing eased on Wednesday morning in a tentative sign of relief among traders after more heightened economic concerns.

New figures from the Office for National Statistics showed the rate of Consumer Prices Index (CPI) inflation slowed to 2.5% in December, from 2.6% in November.

Most analysts had been expecting CPI inflation to stay the same or edge higher.

Furthermore, services inflation – a metric closely watched by the Bank of England – dropped more sharply to 4.4%, from 5% in November.

The latest official figures provided some “good news for the gilt market”, which showed “signs of relief” once trading opened, said Francesco Pesole, foreign exchange strategist for ING.

Yields on government bonds, also known as gilts, eased on Wednesday morning having risen to decades-high levels in the past week.

The 30-year gilt yield dropped about seven basis points to lows of 5.35%, and the 10-year gilt yield was also down about eight basis points to 4.8%.

The pound was also edging higher against the US dollar, having tumbled to 14-month lows in recent days.

Recent fears over so-called stagflation – where inflation is high but economic growth is low – have helped fuel a period of turbulence in the financial markets, which has also been driven by the economic outlook in the US.

Susannah Streeter, head of money and markets for Hargreaves Lansdown, said: “The inflation reading will relieve pressure on UK Chancellor Rachel Reeves, who has been criticised for tax changes in the budget which could lead to price rises ahead and hold back growth this year.

“Government borrowing costs have begun to edge downwards, with the yield on 10-year gilts heading lower, but it remains above 4.8%, at multi-decade highs as investors assess Britain’s debt burden.”

Chancellor Ms Reeves responded to the latest inflation figures by saying she will “fight every day” to improve people’s living standards.

“There is still work to be done to help families across the country with the cost of living,” she said.

“I will fight every day to deliver that growth and improve living standards in every part of the UK.”

Liberal Democrat Treasury spokeswoman Daisy Cooper said the “unexpected fall” in the rate of CPI “offers a glimmer of hope but the reality is the UK economy remains stuck in the mud”.

“Growth is nowhere to be found after the damaging national insurance hike and stagflation remains a real threat,” she said.

December’s headline inflation figure nevertheless remains above the Bank of England’s 2% target level, and experts said it is expected to rise further this year.

Rob Wood, chief UK economist for Pantheon Macroeconomics, said: “Inflation fell in December because of a huge temporary drop in airfares inflation, driven by an early CPI collection date, and an erratic fall in accommodation services.

“Both will reverse in January, so the dovish news today is a temporary reprieve.”

He predicted that CPI inflation will rise to peak at 3.2% by April as higher energy bills add pressure.

But some economists think the latest figures, particularly the sharp drop in services inflation, will encourage the Bank of England to cut interest rates further when policymakers next meet in February.

Sanjay Raja, chief UK economist for Deutsche Bank, said the central bank “will likely feel emboldened to continue its easing cycle in February”.

Mr Wood agreed that the inflation data gives the Bank a “window of opportunity to cut rates in February”, but stressed that policymakers will remain “cautious”.

The ONS said a 1.9% 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.

Clothing and footwear, alcohol and tobacco prices also decreased in December compared with the previous month.

On the other hand, petrol and diesel prices increased in December, compared with November, with the transport sector putting the biggest upward pressure on inflation.

The latest figures also showed that CPIH, a measure of inflation which includes owner-occupiers’ housing costs, remained unchanged at 3.5% in December.

Meanwhile, the Retail Prices Index (RPI) rate of inflation fell to 3.4% in December from 3.6% in November.