Surprise inflation dip relieves pressure on Rachel Reeves and could pave way for February rates cut

A surprise dip in UK inflation last month has provided some reprieve for Rachel Reeves, as financial markets calmed following a recent period of volatility.

The cost of Government borrowing eased yesterday morning in a tentative sign of relief among traders after more heightened economic concerns.

New figures from the Office for National Statistics showed the rate of Consumer Prices Index inflation slowed to 2.5 per cent in December, from 2.6 per cent in November.

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Most analysts had been expecting CPI inflation to stay the same or edge higher.

Furthermore, services inflation – a metric closely watched by the Bank of England – dropped more sharply to 4.4 per cent, from 5 per cent in November.

The latest official figures provided some “good news for the gilt market”, which showed “signs of relief” once trading opened, said Francesco Pesole, foreign exchange strategist for ING.

Yields on government bonds, also known as gilts, eased on Wednesday morning having risen to decades-high levels in the past week.

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Chancellor of the Exchequer Rachel Reeves. Credit: Dan Kitwood/PA WireChancellor of the Exchequer Rachel Reeves. Credit: Dan Kitwood/PA Wire
Chancellor of the Exchequer Rachel Reeves. Credit: Dan Kitwood/PA Wire | Dan Kitwood/PA Wire

The 30-year gilt yield dropped about seven basis points to lows of 5.35 per cent, and the 10-year gilt yield was also down about eight basis points to 4.8 per cent.

The pound was also edging higher against the US dollar, having tumbled to 14-month lows in recent days.

Recent fears over so-called stagflation – where inflation is high but economic growth is low – have helped fuel a period of turbulence in the financial markets, which has also been driven by the economic outlook in the US.

Chancellor Ms Reeves responded to the latest inflation figures by saying she will “fight every day” to improve people’s living standards.

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“There is still work to be done to help families across the country with the cost of living,” she said.

“I will fight every day to deliver that growth and improve living standards in every part of the UK.”

December’s headline inflation figure nevertheless remains above the Bank of England’s 2 per cent target level, and experts said it is expected to rise further this year.

Rob Wood, chief UK economist for Pantheon Macroeconomics, said: “Inflation fell in December because of a huge temporary drop in airfares inflation, driven by an early CPI collection date, and an erratic fall in accommodation services.

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“Both will reverse in January, so the dovish news today is a temporary reprieve.”

He predicted that CPI inflation will rise to peak at 3.2 per cent by April as higher energy bills add pressure.

Martin Sartorius, principal economist at the Confederation of British Industry, said he expects “inflation will stay elevated this year, partly due to Autumn Budget measures contributing to higher prices”.

But some economists think the latest figures, particularly the sharp drop in services inflation, will encourage the Bank of England to cut interest rates further when policymakers next meet in February.

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Sanjay Raja, chief UK economist for Deutsche Bank, said the central bank “will likely feel emboldened to continue its easing cycle in February”.

Mr Wood agreed that the inflation data gives the Bank a “window of opportunity to cut rates in February”, but stressed that policymakers will remain “cautious”.

While Mr Sartorius added: “The next rate cut is still likely to come in February, which will bring some respite for businesses and households as they continue to face high borrowing costs.”

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