In a surprising turn of events, the UK received a much-needed economic boost as inflation unexpectedly eased in December. The news sent bond yields tumbling and raised prospects of interest rate cuts from the Bank of England, providing some relief to Chancellor Rachel Reeves amidst a challenging week.
Inflation Cools, Yields Fall
According to official figures, UK inflation fell to 2.5% in December, down from 2.6% the previous month. The unexpected cooling of prices pushed 10-year gilt yields down by nearly 0.2 percentage points to around 4.7% – the sharpest decline since 2023.
The drop erased most of the past week’s increase in yields, which had forced the chancellor to consider spending cuts in order to meet her fiscal rules. With borrowing costs now easing, some of the immediate pressure on Reeves has lifted.
BoE Rate Cut Expectations Grow
Economists noted that the inflation data has raised the likelihood of the Bank of England cutting interest rates at its next meeting in February. Alan Taylor, a senior BoE policymaker, even suggested rates may need to be lowered to 3.25% this year to avoid inflicting lasting damage on the weakening economy.
“My view is that we’ve made it to the last half mile on inflation, but with the economy weakening, it’s time to get interest rates back toward normal to sustain a soft landing.”
– Alan Taylor, Bank of England Policymaker
Reeves Under Fire
The unexpected inflation drop comes as a relief to Chancellor Reeves, who faced calls for resignation amid accusations that her autumn budget was hurting the economy. Prime Minister Keir Starmer was forced to defend Reeves in fierce Commons exchanges, dampening talk of an emergency budget.
Critics argue that Labour’s policies, including tax increases, would fuel inflation by forcing companies to raise prices. However, the government is trying to get back on the front foot, announcing major investments like a £4bn housing and infrastructure project in Bristol.
Economic Challenges Remain
Despite the positive inflation news, the UK economy still faces significant headwinds. Inflation is expected to tick up in the coming months due to rising energy bills, while stagnant growth continues to plague the nation.
- Energy prices set to rise further as the Ofgem price cap increases
- Business concerns over tax hikes like the £25bn employers’ national insurance increase
- Economy stalling with flat growth expected in the second half of 2024
While the Bank of England had previously signaled a gradual approach to rate cuts, the latest data could accelerate those plans. However, analysts caution that persistently high inflation could still derail rate reductions even as economic growth sputters.
Reeves Focuses on Growth
For her part, Chancellor Reeves remains committed to her economic agenda, emphasizing that growing the economy is the primary path to repairing government finances and improving public services. In a statement, she pledged to “go further and faster” to kickstart growth.
The unexpected dip in inflation has granted Reeves some much-needed breathing room, but significant challenges still lay ahead. With the economy on the precipice and the spectre of inflation still looming, the Chancellor will need to carefully navigate the months ahead to deliver on her economic promises.
