UK Inflation Takes a Surprise Dip, Easing Pressure on Government
A sudden drop in UK inflation has given the government and the Bank of England a much-needed breather. According to the Office for National Statistics, the consumer prices index (CPI) fell to 2.5% in December, down from 2.6% the previous month. This unexpected decrease has boosted expectations that the Bank of England will cut interest rates again next month.
Easing Price Pressures in the Services Sector
The main driver behind this decline was the easing of price pressures in the services sector, which accounts for around 80% of the UK economy. Although inflation remains above the Bank of England’s 2% target, policymakers are likely to look past the anticipated uptick in coming months and consider cutting borrowing rates at their next policy meeting on February 6.
Markets React with Relief
Following the inflation numbers, markets have moved to price in a growing likelihood of a rate cut, bringing relief to Treasury chief Rachel Reeves. The yield on the British government’s benchmark 10-year bond fell by 0.08 percentage point to 4.81%, a significant drop.
Interest Rate Expectations Shift
At the start of the year, financial markets had priced in the prospect of three to four quarter-point interest rate reductions this year from the current level of 4.75%. However, concerns about the UK’s inflation outlook had tempered those expectations in recent weeks. The latest inflation numbers have reversed this trend, with markets now expecting a rate cut.
The Impact on Public Finances
The upward move in interest rates this year will mean that the government will pay out more in interest rate payments, putting pressure on Reeves’ other spending pledges and projections for the public finances. Critics argue that her first budget last October will lead to higher inflation than otherwise would have been the case, as the extra public spending will be largely funded through increased business taxes and borrowing.
The Road Ahead for Inflation
Inflation is still way down from levels seen a couple of years ago, partly due to central banks dramatically increasing borrowing costs during the coronavirus pandemic. As inflation rates continue to fall, central banks have started cutting interest rates, but few economists think that rates will fall back to the super-low levels that persisted in the years after the global financial crisis of 2008-2009.
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