Inflation in the UK unexpectedly fell in December, a move that will likely fuel pressure on the Bank of England to cut interest rates again next month and give the government some breathing room following recent turbulence in financial markets.
Inflation, as measured by the consumer prices index, was 2.5 per cent in the year to December, the Office for National Statistics said on Wednesday, largely as a result of easing price pressures in the services sector, which accounts for about 80 per cent of the UK economy.
That was down from 2.6 per cent the previous month.
Economists had expected no change in the annual rate.
Though inflation has fallen, it remains above the Bank of England's target of 2 per cent.
The bank sets interest rates on what it expects inflation to be in the coming year or two, so if policymakers look past an anticipated uptick in coming months, they might decide to cut borrowing rates at the next policy meeting on February 6.
That would be to the likely relief of Treasury chief Rachel Reeves, who has faced a stream of negative headlines in recent days over her handling of the economy since Labour returned to power last July for the first time in 14 years.
At the start of 2025, financial markets had priced in the prospect of three to four quarter-point interest rate reductions in 2025 from the current level of 4.75 per cent.
However, in recent weeks, concerns about the UK's inflation outlook have tempered those expectations.
That has been evident in the bond market, where the interest rate investors charge the UK government to lend money over 10 years has hit a 16-year high amid concerns over the upcoming economic policies of US President-elect Donald Trump as well as more domestic worries.
Whatever the reason, the bond market changes will likely lead to the government having to pay out more in interest rate payments, putting pressure on Reeves' projections for the public finances.
Inflation is way down from levels seen a couple of years ago, partly because central banks dramatically increased borrowing costs from near zero during the coronavirus pandemic when prices started to shoot up, first as a result of supply chain issues and then because of Russia's full-scale invasion of Ukraine, which pushed up energy costs.