Steep Decrease in UK's December Inflation Rate

Steep Decrease in UK's December Inflation Rate

Welcome to our inflation live blog! Today, Katie Williams and Dan McEvoy, your hosts, bring you all the latest news and insights on UK inflation. It's been a wild ride since the start of the new year, with the UK economy facing a gilt market crisis and discussions about the potential resignation of the chancellor, Rachel Reeves. Let's dive in!

Inflation forecast

Economists at Deutsche Bank expect inflation to come in at 2.68% in December, rounded up to 2.7% by the Office for National Statistics (ONS). Experts at Hargreaves Lansdown also expect the headline figure to inch up slightly.

Not everyone agrees, though. Morningstar has suggested the figure might remain flat at 2.6%, based on FactSet consensus estimates.

Inflation's downward trend and future pressures

The rate of UK inflation has slowed significantly from its peak of 11.1%, reached in October 2022. However, new pressures are looming on the horizon, such as:

• Employer National Insurance contributions set to rise in April, following changes announced in the Autumn Budget.
• The National Living Wage rising by 6.7%, as businesses plan to pass these higher staffing costs on to customers by increasing prices.
• Wide-ranging tariffs that could be imposed by incoming president Donald Trump, potentially disrupting supply chains and adding to business costs.

Consumer Prices Index (CPI)

Reeves is currently in Parliament, facing challenges over the gilt market crisis and her decision to continue with a trip to China last week. Keep up with the latest developments on our gilt market blog.

Long-term inflation outlook

The Office for Budget Responsibility (OBR) has said it expects inflation to average out at 2.6% in 2025. It then expects it to fall to 2.3% in 2026, 2.1% in 2027, 2.1% in 2028, and 2% in 2029.

These OBR figures were published alongside the Autumn Budget in October, but may change if factors on the global stage cause increased geopolitical volatility. Upside risks include Trump's potential tariffs and an escalation in the Middle East.

Trump's impact on UK inflation

Long-term, economists have warned that policies from the incoming president could push global inflation higher. For example:

• US exporters may face higher tit-for-tat duties if Trump introduces widespread tariffs. A new round of trade wars could be inflationary as the higher tariffs feed through to higher prices.
• Many UK businesses operate globally, importing and exporting goods. If tariffs disrupt international supply chains, it will likely result in higher costs for businesses, which may be passed on to consumers.
• Tariffs could also result in a stronger dollar, adding to inflationary woes, as many imports bought on wholesale markets are priced in dollars, which will be more expensive if the greenback takes on more muscle.

Differences between CPI and Retail Prices Index (RPI)

CPI is the official measure of inflation monitored by the Bank of England, but another widely-quoted measure is the Retail Prices Index (RPI). RPI tends to track higher than CPI because it includes costs associated with home ownership.

Where RPI still has relevance is when it comes to setting cost increases for some bills and services. For example, it is used by the government to set annual rail ticket price increases. It is also used to set levies like road tax. Your phone and internet bills could well be linked to RPI, too.

RPI came in at 3.6% in November. December's figure will be released alongside the latest CPI figures tomorrow.

Core and services inflation

Both core and services inflation are closely watched by the Bank of England.

Core inflation strips out volatile categories like energy, food, alcohol, and tobacco, giving a more stable picture of the long-term inflation trend. Meanwhile, services inflation tracks price changes in the services sector, which accounts for around 80% of the UK economy.

Deutsche Bank expects core inflation to come in at 3.48% tomorrow, and services inflation to come in at 4.86%. These figures would be rounded to 3.5% and 4.9% by the ONS. This would leave core inflation unchanged compared to November (3.5%), but constitute a downward movement for services inflation (5%).

The importance of services inflation

As the services sector is the biggest part of the UK economy, tracking price changes in this area can help us understand how embedded inflationary pressures are on a domestic level. The Bank of England wants to see further disinflation in the services sector before cutting rates dramatically. Currently, services inflation is still coming in quite hot.

Outlook for services inflation

It is possible that services inflation will experience a meaningful slowdown this spring.

• Large parts of the services basket are affected by annual changes in index-linked prices, including things like your phone and internet bills. Price hikes generally come into play in March or April and are often tied to CPI or RPI.
• As the overall rate of inflation is considerably lower now than a year ago, bill hikes this year are likely to be less dramatic than last year. This should feed through to the headline services inflation figure.

Energy prices and airfares

although services inflation could slow down in the spring, the tug of war between different parts of the basket will continue. Energy prices are expected to rise further, for example.

The latest forecast from consultancy Cornwall Insight suggests the Ofgem price cap could surge by as much as 3% in April. Experts are blaming geopolitical instability, price cap reforms, and uncertainty over US liquified natural gas exports under a second Trump presidency.

Airfares and hotel costs "appear likely to have weakened" in December, according to Deutsche Bank's chief UK economist Sanjay Raja. This could contribute to a slowdown in the rate of services inflation. This is good news for consumers looking to book a flight or UK getaway.

What's next for UK interest rates?

Markets have been adjusting to the realization that interest rates could stay higher for longer. This is unsurprising given inflationary risks, such as higher energy prices, UK Budget fallout, and Trump's tariffs. Gilt yields have surged as a result, creating a real headache for Reeves. However, several factors are still at play, such as:

• If Reeves is forced to cut spending or raise taxes further to balance the books in light of higher borrowing costs, it could dampen UK growth.
• Tariffs from Trump could also have a negative impact on UK GDP if production slows as a result of supply chain disruption.
• In Streeter's view, a scenario like this could prompt the Bank of England to cut interest rates a little faster than markets are currently expecting. Indeed, it is worth remembering that the Bank of England has a dual mandate. As well as controlling inflation, it is responsible for supporting economic growth.

The impact on personal finances

• Mortgage rates have increased slightly in recent days in response to the volatility in bond markets. Mortgage rates are closely linked to gilt yields, which have surged higher in response to new inflation risks. The average two-year fixed mortgage rate is now 5.49%, according to Moneyfacts. The average five-year rate is 5.27%.
• The savings market hasn't moved dramatically, but the latest developments have helped to normalize the market "with fixed-term bonds finally offering more interest than easy-access accounts," says Mark Hicks, head of active savings at Hargreaves Lansdown.
• Annuity rates have surged too - a positive development for those thinking about buying a guaranteed income in retirement. "The latest data shows a 65-year-old with a £100,000 pension can now get up to £7,425 a year from a single life level annuity with a five-year guarantee," says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. This is up from £7,235 a year last week and up a whopping 48% on the £5,003 that was on offer this time three years ago.

Conclusion

In conclusion, UK inflation is expected to come in at around 2.7% for December 2024, according to forecasts from economists. The overall trend has been downward since a peak of 11.1% in October 2022, but new pressures are on the horizon. Keep an eye on services inflation and energy prices for insight into the health of the UK economy. As for interest rates, while they may stay higher for longer, the Bank of England may cut them faster than currently expected if global events come into play. Stay tuned for more updates on this dynamic economic landscape!

1. Economists at Deutsche Bank and Hargreaves Lansdown have forecasted that UK inflation for December 2022 will come in at 2.7% and slightly above 2.7% respectively.
2. New pressures on the UK economy, such as rising employer National Insurance contributions, higher National Living Wide, and potential tariffs imposed by incoming President Donald Trump, are expected to contribute to inflationary pressures.
3. In their long-term outlook, economists have suggested that policies from President Trump could push global inflation higher, potentially causing higher tit-for-tat duties, disruptions in international supply chains, and increased costs for businesses that may be passed on to consumers.
4. Personal finance implications of the current economic situation include higher mortgage rates, interest rates on savings remaining relatively steady, and higher annuity rates for retirees.
5. As the trend for UK inflation has been downward since October 2022, it is important to keep an eye on services inflation and energy prices for insight into the health of the UK economy, as these factors could impact interest rates and the overall trajectory of UK inflation.

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