In a surprising turn of events, UK inflation fell to 2.5% in December 2024, marking a lower-than-expected reading and offering some relief to households and businesses grappling with the cost of living. Data released by the Office for National Statistics (ONS) on Wednesday highlighted that core inflation, which excludes volatile food and energy prices, also slowed to 3.2%, down from 3.5% in November.
This marks a notable shift from earlier months, as the consumer price index (CPI) had risen to 2.6% in November. Economists polled by Reuters had anticipated inflation to hold steady at that level, making the December reading a positive surprise.
A Closer Look at the Numbers
The UK’s inflation rate hit a three-year low of 1.7% in September before gradually climbing due to rising fuel costs and services fees. In December, however, the annual services inflation rate fell to 4.4% from 5% in November, further contributing to the overall slowdown.
The British pound, which initially experienced a decline following the data release, reversed its course and rose by 0.1% against the dollar by 8:15 a.m. London time.
Bank of England’s Next Steps
This slowdown in inflation adds complexity to the Bank of England’s (BoE) decision-making ahead of its next meeting on February 6. The central bank is widely expected to cut its key interest rate from 4.75% to 4.5%, despite lingering inflationary pressures such as resilient wage growth and uncertainties surrounding the UK’s economic outlook.
The BoE’s inflation target remains at 2%, and policymakers face a delicate balancing act of supporting growth while keeping inflation in check. Ruth Gregory, Deputy Chief UK Economist at Capital Economics, noted that the latest inflation data strengthens the case for a 25-basis-point rate cut in February.
“Our forecast is that CPI inflation will rebound in January, perhaps to almost 3.0%, and that inflation will be a bit higher than most expect in the first half of this year. But we expect it to drop below the 2% target next year as the persistence of inflation fades further,” Gregory said in an emailed statement.
Fiscal Challenges and Economic Outlook
The inflation slowdown arrives against the backdrop of a challenging economic environment. The UK economy has been facing sluggish growth prospects, with external pressures, such as potential trade tariffs under incoming US President Donald Trump’s administration, and domestic fiscal challenges weighing heavily.
Tax hikes announced in the October budget, set to take effect in April, have stirred concerns among businesses, which warn that higher taxes could stifle investment, hiring, and growth. Chancellor Rachel Reeves has committed to maintaining fiscal discipline despite these challenges, pledging to adhere to self-imposed rules that require all day-to-day spending to be met by revenues and government debt to trend downward.
However, adhering to these fiscal rules is proving to be a significant challenge. Ben Zaranko, Associate Director at the Institute for Fiscal Studies, described Reeves’s position as “unenviable.” He pointed out the difficulty of balancing promises to avoid austerity, maintain strong public services, and prevent further tax increases, all while facing higher borrowing costs.
“This unfortunate predicament is largely the consequence of a difficult fiscal inheritance and global economic factors,” Zaranko said. “If higher interest rates wipe out the so-called ‘headroom,’ something will have to give.”
What It Means for Households and Businesses
For households, the easing of inflation provides a modest reprieve from rising costs, particularly in services. However, uncertainties surrounding wage growth and fiscal challenges may keep some pressure on disposable incomes.
For businesses, the inflation data offers mixed signals. While easing inflation may reduce input costs, the upcoming tax increases and ongoing economic uncertainties could dampen confidence and investment in the near term.
Looking Ahead
The December inflation figures are welcome news for policymakers, but challenges remain. The Bank of England faces a tough decision in February, and the government must carefully navigate its fiscal strategy in the face of growing economic headwinds.
As 2025 begins, the UK finds itself at a crossroads. Policymakers, businesses, and households alike will need to tread carefully to ensure that this period of relative calm in inflation translates into sustainable economic growth.
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