Surprise fall in inflation boosts interest rate cut hopes

In December, the UK experienced an unexpected drop in inflation, which is the rate at which prices for goods and services rise. This decline has raised hopes that the Bank of England might consider cutting interest rates in the near future. Specifically, inflation fell to 2. 5% for the year ending in December, down from 2. 6% the previous month. This marks the first decrease in inflation in three months. The primary factors contributing to this decline were a reduction in hotel prices and smaller-than-usual increases in airfare. Despite this positive news, prices are still rising faster than the Bank of England's target rate. In recent weeks, borrowing costs in the UK had been on the rise, but following the inflation report, these costs decreased, providing some relief to Chancellor Rachel Reeves, who has faced criticism regarding her budget policies. Government borrowing costs had reached their highest level in 16 years, and the value of the pound had fallen to a 14-month low. After the inflation figures were released, investors began to speculate more on the possibility of an interest rate cut next month, with some even anticipating a second cut by the end of the year. Last month, the Bank of England opted to maintain interest rates at 4. 75%, citing that the UK economy had not performed as well as expected. Ruth Gregory, the deputy chief UK economist at Capital Economics, stated that the latest inflation figure strengthens the argument for a potential cut to 4. 5% in February. Inflation is significantly lower than its peak in October 2022, when prices surged, leading to a higher cost of living for households and increased interest rates, which made loans, credit cards, and mortgages more expensive. Economists had predicted that inflation would remain unchanged last month. The Office for National Statistics (ONS) reported that easing price increases for restaurants and falling hotel prices were key factors in driving inflation lower. However, Grant Fitzner, the chief economist at ONS, noted that these decreases were countered by rising fuel costs and the prices of second-hand cars. Following the release of the UK inflation data, government borrowing costs returned to levels seen the previous week, and the pound rose slightly to $1. 22. The costs of debt in the UK further decreased after figures from the US indicated that core inflation had also fallen more than anticipated. Chancellor Reeves acknowledged that there is still work to be done to assist families with the cost of living, but she emphasized that the government has taken measures to protect workers from higher taxes and has increased the minimum wage. In contrast, shadow chancellor Mel Stride criticized the government, claiming that economic growth has been severely hindered and called for Reeves to urgently clarify her plans for improvement.