UK inflation unexpectedly drops to 2.5%, easing pressure on Rachel Reeves Inflation

British inflation unexpectedly fell in December, giving Chancellor Rachel Reeves some breathing room after a turbulent week in financial markets.

As the government faces economic pressure, data from the National Bureau of Statistics showed that the consumer price index fell back to 2.5%, down from 2.6% in November, indicating a slowdown in price increases.

City economists had forecast inflation would remain unchanged from last month. However, inflation remains above the Bank of England's 2% target, and experts warn it could rise above 3% before the end of the year.

Grant Fitzner, chief economist at the ONS, said: “Hotel prices have fallen this month and inflation has slowed slightly, having risen a year ago. Tobacco costs are another driver of the decline, Price increases were lower than the same period last year.

“This was partially offset by fuel costs and used car costs, which posted annual growth for the first time since July 2023.”

Amid a key economic update, the latest snapshot could open the door for the Bank of England to cut interest rates as early as next month as the government tries to calm jittery bond market investors.

Shortly after the data was released, the pound fell about 0.3% against the dollar to below $1.22.

Responding to December's inflation data, Reeves said: “There's still a lot of work to be done to help families across the country reduce the cost of living. That's why the government is taking action to protect working people's paybills from higher taxes, freezing fuel duty impact, and raised the national minimum wage.

“In our 'Plan for Change' we made clear that growth is our priority and getting more money into the pockets of working people. I will fight every day to deliver growth and improve living standards across the UK.”

The latest snapshot showed core inflation, which excludes volatile items such as energy, food, alcohol and tobacco, rose less than expected in December, falling to 3.2% from 3.5% in November. Inflation in the services sector, which is closely watched by the Bank of England, also fell to 4.4% from 5%.

Threadneedle Street has said it will take a gradual approach to cutting borrowing costs after inflation eases from a peak of more than 11% in late 2022, when soaring energy prices sent the cost of living soaring. After interest rate cuts in August and November last year, UK interest rates remained at 4.75%.

However, analysts warned that sticky inflation could undermine the central bank's interest rate cuts despite stalling economic growth. Investors also warned Reeves could be forced to backtrack on her pledge not to raise taxes if borrowing costs continue to rise, potentially violating her fiscal rules.

The German chancellor said on Tuesday she was prepared to make emergency spending cuts to balance the books if needed, while saying her priority was to boost economic growth “further and faster” to calm financial markets.