Wed, 15 Jan 2025

Surprise fall in inflation boosts interest rate cut hopes

Inflation falls for the first time in three months, sparking expectations rates may be cut to 4.5% in February.
UK inflation unexpectedly dropped to 2.5% in December, down from 2.6% in November, marking the first fall in three months. The decrease was driven by lower hotel prices and slower increases in airfares, but overall prices still rose faster than the Bank of England's target. Investors now expect an interest rate cut next month as a result of the lower inflation figure, with some predicting a second cut before the end of the year. This would be a reduction from the current 4.75% rate, which was maintained last month despite weaker-than-expected economic performance. The fall in inflation has also led to a decline in UK borrowing costs and an increase in the value of the pound, easing pressure on Chancellor Rachel Reeves whose budget policies have been criticized for contributing to market turmoil. Government economists say the data "strengthens the case" for a rate cut next month, with Capital Economics predicting that interest rates could be reduced to 4.5% by February. Inflation has decreased significantly since its peak in October 2022, but remains higher than the Bank of England's target. The Office for National Statistics (ONS) attributed the decrease in inflation to lower prices for restaurants and falling hotel costs, as well as slower increases in tobacco products. However, rising fuel and second-hand car costs offset some of these gains. Following the release of the data, government borrowing costs fell back to last week's levels, while the pound rose slightly to $1.22. The Chancellor acknowledged that there is still work to be done to help families with the cost of living, but emphasized that her budget policies have protected working people's pay from higher taxes. Investors are calling for more detail on the UK's plans to support the economy, with Rathbones Investment Management predicting that tax breaks and specifics on industry support will be key in calming market nerves.
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