- Analysts still expect inflation to fall below the 2 per cent target this spring
- BoE will want to see more progress on wage growth before cutting rates
The headline rate of inflation rose to 4 per cent in December, a small but unexpected increase on November’s 3.9 per cent. Core inflation, which strips out more volatile food, energy and tobacco prices remained unchanged at 5.1 per cent.
According to today’s Office for National Statistics (ONS) release, higher tobacco duties and persistent services inflation pulled the figure upwards. More encouragingly, the largest downward contribution came from food and non-alcoholic beverages. Despite the uptick, inflation remains at the second-lowest level since September 2021.
Will the inflation fall again?
Despite today’s surprise, analysts expect inflation to progress swiftly towards the 2 per cent target this year. An expected fall in the energy price cap in April could see inflation hit 2 per cent as early as the spring.
Analysts at Dutch bank ING expect to see broad-based falls in inflation over the coming months, thanks to downward pressure from food and drink and services prices. ING’s forecasts see the headline rate of inflation falling to 1.5 per cent by May, and remaining below the 2 per cent inflation target until November.
Will we see rate cuts soon?
Given that interest rates were hiked to drive inflation back to target, there soon could be a very strong case for cutting them.
The latest moves in inflation have certainly caught UK rate-setters off guard. The Bank’s most recent forecasts suggested that inflation would hover at about 4.5 per cent in the first three months of 2024, taking until the end of 2025 to reach 2 per cent.
Since then, futures prices for wholesale gas have halved, putting the inflation rate on a far more optimistic trajectory. Deutsche Bank analyst Sanjay Raja said: "One thing is for sure, the [Bank of England committee] can no longer ignore the downside news to their outdated projections."
Did markets get ahead of themselves?
But don’t expect a u-turn from the BoE this month. At the end of the year, rate-setters made it clear that they were still worried about wage inflation and warned that they wanted to see sustained evidence of pay pressures cooling.
On Tuesday, ONS data showed that average growth in regular pay had cooled to 6.6 per cent: this is lower than last month’s 7.2 per cent figure, but high enough to continue to put upward pressure on the inflation rate.
Following the release, Investec economist Philip Shaw said: "The direction of wage growth is encouraging but the Monetary Policy Committee will need to see pay growth subside further before it seriously contemplates bringing interest rates down." He sees scope for UK rate cuts in June.
Following today’s inflation data, Ed Monk, associate director at Fidelity International, said: "The rise in inflation today suggests that the market has got ahead of itself in expecting early rate reductions." He added that “predictions of a Spring cut look optimistic this morning”.
