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UK inflation unexpectedly fell in December to 2.5%, down from 2.6% in November. This marks the first decline in three months and has fueled hopes that the Bank of England may reduce interest rates as soon as next month.
The dip in inflation was mainly driven by falling hotel prices and smaller-than-usual increases in airfares. However, inflation remains above the Bank of England’s 2% target, indicating that the cost of living is still rising faster than desired.
Borrowing Costs Ease
The news of the inflation decline had an immediate impact on financial markets. Government borrowing costs, which had surged to their highest level in 16 years, fell, while the pound rose slightly to $1.22. The easing of borrowing costs has brought some relief to Chancellor Rachel Reeves, who has faced criticism for policies perceived as contributing to market instability.
Before the inflation figures were released, the UK economy was already under pressure, with no growth recorded between October and December. Investors are now betting on an interest rate cut to 4.5% in February, with another reduction anticipated later this year.
Ruth Gregory, Deputy Chief UK Economist at Capital Economics, said the inflation data “strengthens the case” for a rate cut. Economists had expected inflation to remain steady in December, making this drop an encouraging surprise for financial markets.
The Role of Rising and Falling Prices
While lower hotel prices and reduced restaurant price hikes helped to cool inflation, rising costs in other areas remain a concern. For instance:
- Fuel and second-hand cars: Prices in these categories continued to climb.
- Tobacco products: Price increases slowed compared to previous months but still added to overall inflation pressures.
The Office for National Statistics (ONS) noted that the balance of falling and rising costs kept inflation above the Bank of England’s target, signaling the complexity of the UK’s economic situation.
Housing and Living Costs on the Rise
The housing market and rental sector continue to experience significant challenges.
- Average rents: Increased by 9% in December compared to the previous year.
- House prices: Rose by 3.3% in the 12 months to November, with the largest increases in Northern Ireland.
In addition, inflation-linked phone and broadband contracts are set to increase bills starting in April, with broadband costs rising by an average of £21.99 annually and mobile contracts increasing by £15.90.
Challenges for Businesses
The inflation drop hasn’t alleviated pressures for all businesses. Rising wages, national insurance contributions, and reduced business rate relief are forcing many small enterprises to make tough decisions.
Jonny Gettings, Director of Operations at Ennio’s restaurant and small hotel in Southampton, said they might consider shrinking their menu or reducing opening hours to manage costs. “Cutting staff hours would be the last scenario,” he noted. However, price increases could risk driving customers away.
Chancellor’s Stance and Criticism
Chancellor Rachel Reeves welcomed the inflation drop but acknowledged that “there is still work to be done to help families across the country with the cost of living.” She highlighted the government’s measures, including raising the minimum wage and protecting working people’s payslips from higher taxes.
Despite these assurances, Shadow Chancellor Mel Stride criticized the government’s economic strategy, accusing it of “killing growth stone dead.” Reeves has hinted at plans to accelerate Labour’s industrial strategy announcements to address market concerns.
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