The surprise dip in the cost of living has divided the market on whether the Bank of England will move to cut rates next month to help a flagging economy, or wait until the spring to see if rising prices have cooled.
Prices rose 2.5% in the year to December, down from 2.6% the month before, according to the Office for National Statistics, as hotel stays and tobacco costs eased.
Core services inflation fell to 4.4% from 5% at an annual rate, a closely watched figure by the Bank’s rate-setting Monetary Policy Committee, which holds in next meeting on 6 February. The Bank’s headline inflation target is 2%.
However, annual wage growth, another key number for the committee, came in at 5.2% between August to October.
Bank of England governor Andrew Bailey had said in December that he expected four ‘gradual’ base rate cuts this year.
Although in recent weeks the market had taken a gloomier outlook, expecting just two.
But today’s fall in the cost of living has caused some economists to take a more upbeat view.
Deutsche Bank chief UK economist Sanjay Raja says: “The slowdown in consumer price inflation was broad-based.
“Softer rents inflation, transport and travel services inflation, and hospitality and leisure inflation all contributed to the downside miss we saw today – as reflected in varying measures of ‘core services’ inflation.
“Bottom line, the Bank of England will likely feel emboldened to continue its easing cycle in February. And rate cut expectations further out should ease on the back of today’s data.”
However, some in the market say geopolitical tensions in the Middle East and Ukraine, uncertainty over possible trade tariffs imposed by incoming US President Donald Trump and the expectation of energy prices rises later this year, will push back base rate cuts.
Quilter Investors investment strategist Lindsay James adds: “Markets are now sceptical about the prospect of further rate cuts in the UK before May, pricing in less than two quarter-point cuts for the year as a whole.
“While this data will show some encouraging signs of progress, much of this is negated once mortgage costs are factored in, inflation including owner occupiers’ housing costs remain unchanged at an annual rate of 3.5%.
“With government bond yields rising in recent weeks, the upward pressure on mortgages remains in place.
“Consequently, the UK economy is unlikely to experience interest rate cuts in the near term, adding to the headaches at the Treasury as growth is likely to remain anaemic.”
The mortgage industry is hopeful the Monetary Policy Committee will cut the base rate next month, rather than waiting for its March meeting.
John Charcol mortgage technical manager Nicholas Mendes points out: “While questions remain about whether the Bank of England will reduce the bank rate in February, it is still too early to rule out such a move.
“Inflation is expected to remain above the Bank of England’s 2% target for much of 2025, and with the economy in need of a boost, a 0.25% rate cut could still be possible.
“The Bank of England’s cautious approach to rate cuts in 2024 means any potential reduction in February is unlikely to risk adverse effects on long-term inflation trends or expectation.
“A rate cut or a closely split vote, such as 5–4, should not be ruled out.”
