Inflation edges down in December: "The UK's economic Whac-A-Mole continues"

This morning’s inflation figures show a slight drop, with CPI inflation easing to 2.5% in December from 2.6% in November. While this offers a glimmer of hope, it’s a modest change that doesn’t mean the pressure on household finances is over just yet. However, it may help ease the pressure on gilt yields, which have been elevated in recent weeks and are a key driver of government borrowing costs. Looking ahead, there’s still significant upward pressure on inflation. Rising energy costs, food prices, and ongoing supply chain issues could keep inflation stubbornly high in the months to come. For borrowers, this means that mortgage rates are unlikely to drop significantly anytime soon, as lenders remain cautious about future market conditions. For the Chancellor, this small dip provides some brief breathing room. However, with government borrowing costs still soaring and most businesses expressing little confidence in her economic plans, the challenges ahead remain significant.

To see inflation drop is welcome but we are by no means out of the woods yet. The inflationary impact of the Budget has yet to hit home and that could mean this is a blip rather than the beginning of a trend. How this marginal drop in inflation impacts mortgage pricing and confidence among lenders remains to be seen but it does give the Bank of England a little more wiggle room than it perhaps expected at its next Monetary Policy Committee meeting.

This small drop in inflation may prove significant and could start turning the tide. We have seen gilt and swap rates rise significantly over the past week, so today’s data will help settle the markets. Despite the market increases we have seen, lenders largely haven’t increased their mortgage rates in line with these. The hope will be, following today’s figures, that the markets stabilise and lenders will not need to pass the increases onto mortgage holders.

The UK's economic Whac-A-Mole continues, with a surprise drop in headline inflation potentially providing some relief for markets after a horrendous week of policy concerns. Although this is still very much a shallow victory, the lower-than-expected inflation figure could help to ease some concerns about the government's fiscal plans, potentially providing more room for manoeuvre in future policy decisions. However, while inflation has dropped, it still remains above the Bank of England's 2% target, and when combined with the sluggish economic growth outlook, worsened by the recent Budget, the spectre of stagflation is still not fully vanished.

Rachel Reeves will have a spring in her step this morning. A slight dip in the rate of inflation was the positive news that nobody was expecting. This should drastically improve the likelihood that the Bank of England reduces the base rate next month. Come on Bailey, the ball's in your court — help us out.

The recent decline in inflation, labelled a 'surprise,' is relatively minor in the broader context. While inflation came in below expectations this month, the overall trend remains clearly upward. A 0.1% monthly change is unlikely to significantly influence bond yields, the Bank of England's decisions, or the wider economic outlook. The real challenges are set to emerge in the coming months—particularly in March, April, and May—when employer National Insurance contributions are due to rise. Many employers have already indicated they cannot absorb these additional costs. Compounding this is the recent spike in oil prices, which will soon translate into higher petrol costs. Consequently, prices are expected to climb further, making a second wave of 1970s-style inflation appear increasingly likely.

The small reduction in inflation is surprising given all the economic indications painting a different picture. However, it is more likely that these factors are yet to fully affect inflation in the months ahead. Even so, this modest decline will do little to ease the pressure on Reeves in her role as Chancellor.

Some good inflation news will help to thaw the chill that has reverberated around the economy over the last few weeks, and however slight the reduction it is welcomed. Whether this is enough to have an effect on swap rates remains to be seen and we are still in higher for longer interest rate territory. That said, every little helps.

Rachel Reeves must be breathing a sigh of relief over her morning cornflakes today, but the same pressing fiscal challenges remain: sluggish growth, rising borrowing costs, and a weakening pound. If she can tackle these issues, perhaps her next bowl of cereal will come with a well-deserved free toy.