UK inflation rose to 3.4% in December, up from 3.2% the previous month, according to data released this morning by the Office for National Statistics (ONS), complicating expectations that interest rates could be cut early in the year.
The increase, while modest, underlines how difficult the final stretch back to the Bank of England’s 2% target may prove. The more volatile components of the Consumer Price Index (CPI) mask a more persistent problem in services inflation, a key concern for policymakers and investors.
Isabella Galliers-Pratt, senior investment director at Rathbones, said the latest figures were “a mild setback”.
“The increase was driven largely by services and by further rises in food prices,” she said. “Despite some encouraging progress in recent months, inflation remains stubbornly elevated at a time when the chancellor is trying to steady the public finances.”
Part of the December rise reflects temporary factors. Andrew Wishart, senior UK economist at Berenberg, said a jump in airfares and higher food, alcohol and tobacco prices explained much of the move higher. Airfares alone added 0.06 percentage points to headline inflation, while food-related categories contributed a further 0.08 percentage points.
Airfare inflation is notoriously volatile, Wishart said, suggesting the ONS captured the Christmas travel surge that had been expected to fall outside the data window. On that basis, he expects inflation to ease back to around 3% in January as airfares normalise and energy bills fall.
However, beneath those swings lies a more uncomfortable trend for the Bank of England. Wishart highlighted the “steady, persistent” 4% annual increase in hotel, restaurant and other services prices as a sign that some areas of the economy are proving slower to cool than hoped.
“Some stickiness in services prices in the UK December inflation data likely rules out an interest rate cut at the Bank of England’s next meeting,” he said.
The problem for policymakers is that inflation persistence is colliding with a weakening labour market. Private sector wage growth has fallen to its lowest level in five years and payrolls dropped by 43,000 in December, the sharpest monthly fall since 2020. In theory, that should ease service prices over time.
Galliers-Pratt said the Bank now faces a “finely balanced” outlook as it tries to weigh a cooling jobs market against an inflation backdrop that continues to limit its room for manoeuvre.
“Today’s rise, though modest, reinforces a broader theme: inflation has been more persistent than many hoped,” she said, adding that geopolitical uncertainty was also keeping the outlook for imported inflation unsettled.
As a result, markets had already priced out a February rate cut before today’s data, a view that remains intact. Expectations have now shifted towards later cuts, potentially from March onwards, assuming inflation resumes its downward path.
Berenberg’s Wishart still expects CPI inflation to fall to 2% by the summer, with much of the decline coming in April as last year’s large administered price rises drop out of the annual comparison and government support for household energy bills takes effect. Until then, inflation is likely to hover close to 3%.
For investors and savers, the implications are mixed. Higher-for-longer rates continue to support cash returns, but persistent inflation erodes purchasing power and complicates the outlook for risk assets sensitive to domestic demand.
For households, Galliers-Pratt said some relief is still in sight, with energy bill cuts and freezes on rail fares and prescription charges expected to help later in the year. But progress back to more comfortable inflation levels may be slower and less predictable than many had hoped.
“For now, the path back to more comfortable inflation levels is still in sight,” she said. “But it may take longer than expected and progress is unlikely to be linear.”