UK inflation cooled from 3.4% in December to 3% in January, reinforcing market expectations that the UK is moving decisively toward the conditions required for monetary easing.
Danni Hewson, head of financial analysis at AJ Bell, said: “The latest inflation figures are encouraging, although they effectively turn the clock back to where we were a year ago, before the impact of Rachel Reeves’ first Budget and Donald Trump’s trade skirmishes made their mark.
“For the Bank of England, the latest data could give a green light for an interest rate cut in March, with market expectation for a cut rounding off at 85% after today’s release.”
When the Bank’s Monetary Policy Committee met earlier this month, the vote was split five to four in favour of holding rates steady, citing a lack of solid evidence that a cut was the right move at that time.
“The plethora of recent data should be more than enough to give at least one member a good shove to the other side of the seesaw,” said Hewson.
He noted that economic conditions may be such that the Bank can afford to deliver as many as three rate cuts in 2026, although he said “that’s far from nailed on”, acknowledging that service sector inflation remains stubbornly high.
The drop in inflation was largely driven by lower energy prices and falling food prices, while core inflation slowed from 3.2% to 3.1%. Services inflation proved stickier, rising from 4% to 4.3%.
Chris Higham, senior portfolio manager at Aviva Investors, said persistent services inflation points to a continually slower adjustment process, where domestic price pressures ease only gradually and policy normalisation takes longer than markets periodically expect.
“For long-term positioning, that argues for restraint rather than urgency,” he said.
“The case for reducing portfolio risk within gilts is weaker than it was a year ago but the data also doesn’t support a return to rapid easing narrative.”
Higham said portfolios need to be positioned for an environment “where real yields remain positive, carry matters and policy uncertainty fades only slowly”.
This favours a more selective approach rather than broad duration bets, he noted, adding that gilts continue to play an important role as a stabiliser but sustained rallies will require clearer evidence that wage-driven inflation is ending.
“In credit, fundamentals and technicals remain more important than macro timing and consequently, the asset class remains well supported,” Higham said.
The fall in inflation comes hot on the heels of the UK’s latest employment figures, which show unemployment has reached 5.2% – its highest level in five years.
Luke Bartholomew, deputy chief economist at Aberdeen, said: “With the labour-market data pointing to ongoing weakness in employment and a further softening in pay growth, most policymakers are likely to look through any short run stickiness in the services data.”
David Smith, manager of the Henderson High Income fund, said lower inflation and reduced borrowing costs should create a more favourable operating environment for UK businesses while boosting consumers’ purchasing power.
“Investors should therefore be looking more closely at mid-cap, FTSE 250-listed stocks, as these provide greater exposure to the domestic economy when compared to other, more intentionally focused indexes such as the FTSE 100,” he said.
Smith added that the FTSE 250 currently offers a more attractive 3.4% dividend yield compared to the 2.9% on offer through the FTSE 100.