Written by Suban Abdulla and David Milliken
LONDON (Reuters) – Britain’s inflation fell sharply last month and key measures of inflation – tracked by the Bank of England – fell sharply, according to official data to be received by Finance Minister Rachel Reeves after a market sell-off.
The annual rate of inflation fell to 2.5% in December from 2.6% in November, the Office for National Statistics said, in contrast to economists’ expectations in a Reuters poll for it to remain unchanged.
Inflation is expected to rise again due to higher energy prices, continued rapid wage growth and short-term stimulus in the October budget, and many analysts predict it will reach 3% in early 2025. Reeves said “there is still work to be done”.
But investors have increased their bets on the BoE cutting interest rates, placing an 84% chance of a first-quarter rate cut in Feb. 6, the date of the next planned monetary policy announcement.
The two rate cuts for 2025 were fully priced into the market, from around 60% probability ahead of the data.
British government bond yields have fallen from ten-year highs in recent days. Sterling fell after the figures were published but reversed course to remain largely unchanged on the day.
The BoE said Britain’s persistent inflation means it will gradually reduce borrowing costs despite signs the economy is losing steam.
The prospect of a rate cut has contributed to rising borrowing costs that have threatened to slow Reeves down from his budget policies, which would have required him to cut public spending.
“For now, this soft report should help reassure investors that the BoE can continue its gradual rate-cutting cycle, and we expect the next rate cut in February,” said Luke Bartholomew, deputy economist at abrdn.
The BoE forecast in early November that inflation would be 2.5% in December before rising to around 2.75% in the second half of 2025.
“Policymakers and Treasury officials will breathe a sigh of relief,” said Scott Gardner, an investment strategist at JP Morgan who manages digital asset manager Nutmeg.
COMMITMENT RATINGS ARE GOOD
The drop in the headline CPI showed cheaper hotel rooms, air fares and clothing and a smaller increase in cigarette prices than in 2023.
The ONS said part of the 26% drop in air fares compared to December 2023 may have been because this December – unlike 2023 – data was collected on return air fares on Christmas Eve or New Year’s Eve. These are the least popular dates for return trips.
Core measures of inflation, which the BoE sees as a better guide to medium-term price pressures, were also cut more than expected.
Inflation, which excludes the prices of electricity, food, alcohol and tobacco, fell to 3.2% from 3.5% in November.
Services inflation stood at 4.4% in December – the lowest since March 2022 – compared with 5.0% the previous month, the ONS said. Economists had predicted it would drop to 4.9%.
“Are we on a straight path to downward inflation? We don’t think so,” Sanjay Raja, Deutsche Bank (ETR 🙂 The UK’s top economist, he said, points to increases in April in the minimum wage and social security contributions for employers and higher energy and food costs.
“That said, the price jump is likely to be temporary, as inflation is expected to normalize to more consistent levels next year.”
Factory gate prices in December were 0.1% higher than a year ago after falling 0.5%.
