Why has inflation fallen and why is this good news for the Government?
The latest data has raised expectations that the Bank of England could cut UK interest rates again next month.
UK inflation unexpectedly slowed in December, according to new figures from the Office for National Statistics (ONS).
The Consumer Prices Index (CPI) data helped provide a boost to the Government after fears over the economic outlook drove turbulence in the financial markets in recent days.
It also raised expectations that the Bank of England could cut UK interest rates again next month.
Below, the PA news agency looks at what the latest inflation data means for households, the economy, and the Government.
– What is inflation?
Inflation is the term used to describe the rising price of goods and services.
The inflation rate refers to how quickly prices are going up.
December’s inflation rate of 2.5% means that if an item cost £100 a year ago, the same thing would now cost £102.50.
It is below the 2.6% inflation rate recorded in November, meaning that prices are still increasing, but at a slower rate than they previously were.
– What made inflation go down?
The ONS said the biggest driver of lower inflation last month was the change in hotel and restaurant prices.
Hotel prices fell by 1.9% in December, compared with a rise of 3.1% monthly a year ago. Restaurants and cafe prices still increased but by 0.2%, compared with a 0.3% rise a year ago, the ONS said.
Alcohol and tobacco prices also decreased between November and December, as did clothing and footwear costs.
On the other hand, the transport sector provided the largest upward pressure on inflation last month.
The average price of petrol rose by 1.4p per litre to 136.2p per litre, and the average price of diesel rose by 2p per litre to stand at 142.5p per litre in December.
– Why is this good news for the Government?
Data showing that price rises slowed in December will have come as a relief to the Government after a period of turbulence in the financial markets, experts said.
In recent days, the value of the pound has dropped sharply and the cost of government borrowing has risen to decades-high levels.
If inflation had risen in December, it could have fuelled fears that the economy was heading for so-called stagflation – where inflation is high but economic growth is low.
New gross domestic product (GDP) figures published on Thursday will provide more information on the outlook for the economy.
– What has caused the recent weakness?
The volatility has been driven by a number of factors, including the economic outlook in the US, and political uncertainty linked to the upcoming Trump administration.
Michael Saunders, a senior policy adviser for Oxford Economics, said it is not a “UK-centred crisis”, with other economies also seeing the cost of government borrowing rise.
But he said it “partly reflects domestic factors”, adding that the “scale of the increases in planned public spending in the late-2024 UK Budget may have added to worries that the new Labour government will find it hard to restrain public spending.”
Other experts have linked the recent market turbulence to the Government’s plans for the nation’s finances.
– Will inflation rise again?
Most economists think the December dip reflected a temporary respite, with inflation set to rise again from 2025.
Rob Wood, chief UK economist for Pantheon Macroeconomics, said he was forecasting CPI to peak at 3.2% in April, with higher energy prices expected to put more pressure on overall living standards.
Sanjay Raja, chief UK economist for Deutsche Bank, agreed that “price momentum will likely pick up from here”.
“Increases to the National Living Wage and employer national insurance contributions will, we expect, push inflation higher over 2025,” he said.
“Higher energy prices won’t help either – nor will higher food prices, which are starting to emerge.”
– What does the fall in inflation mean for interest rates?
The latest figures are widely thought to encourage the Bank of England to cut interest rates further when policymakers next meet in February.
Russ Mould, investment director at AJ Bell, said it “strengthens the argument for the Bank of England to continue cutting interest rates”, consequently raising hopes that “mortgage rates will go down and more people will be able to afford to get on to the housing ladder”.
Pantheon Macroeconomics’ 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”.
Interest rates are currently set at 4.75%, having last been cut in November.
