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UK Inflation Falls in December Offering Potential Relief to Bank of England and Government

Prime Highlights:

UK inflation decreased to 2.5% in December, down from 2.6% in November.

Services sector easing contributed to the reduction in inflation.

Inflation remains above the Bank of England’s 2% target.

Key Background:

UK inflation unexpectedly eased in December, providing a potential reprieve for both the Bank of England and the government as financial markets remain turbulent. The Office for National Statistics (ONS) reported that the Consumer Prices Index (CPI) inflation rate stood at 2.5% in December, slightly down from 2.6% in November. The decrease was largely attributed to easing price pressures within the services sector, which comprises approximately 80% of the UK economy.

This decline in inflation, while still above the Bank of England’s target of 2%, could create a window of opportunity for policymakers to consider lowering interest rates in February 2025. Many economists had predicted that inflation would remain unchanged, so the drop has taken markets by surprise. A rate cut would offer relief to the Treasury, which has faced mounting criticism over the handling of the economy under Labour leadership, particularly since the party’s return to power in July 2024.

Despite the recent dip, inflation remains higher than the Bank’s target, meaning that policymakers will need to navigate carefully when making decisions about future interest rates. A rate cut would likely be in response to anticipated inflationary pressures over the coming months, with markets predicting up to four quarter-point reductions in 2025. At present, the UK base interest rate stands at 4.75%, and any reduction would offer a boost to the economy as it seeks to recover from post-pandemic challenges.

The recent easing of inflation may also offer some relief to Treasury chief Rachel Reeves, who has faced negative headlines regarding economic policy. However, concerns about the UK’s inflation outlook have, in recent weeks, tempered expectations for aggressive rate cuts, as evidenced by rising bond yields. The interest rate charged on UK government debt over a 10-year period has reached its highest level in 16 years, reflecting both domestic uncertainties and global economic factors, including the policies of the incoming US administration. Overall, while inflation has significantly reduced from its peak in previous years—partly due to central bank actions and external events such as the Ukraine conflict—further challenges lie ahead. These include managing the impact of interest rate adjustments and the pressure on public finances stemming from higher borrowing costs.