UK inflation saw an unexpected rise in January, reaching 3% and complicating the Bank of England’s plans for gradual interest rate cuts. The increase comes at a time when the economy is already showing signs of weakness, making it harder for policymakers to strike a balance between controlling inflation and supporting growth.
According to the latest data from the Office for National Statistics (ONS), consumer prices rose by 3% compared to the same period last year, up from 2.5% in December. This figure exceeded economists’ expectations, who had forecast inflation to rise to 2.8%. The unexpected jump suggests that inflationary pressures remain stronger than anticipated, posing a challenge for monetary policy.
The sharp rise in inflation keeps it significantly above the Bank of England’s 2% target, raising concerns that cutting interest rates too soon could fuel further price increases. At the same time, the UK economy remains fragile, growing by just 0.1% in the final quarter of 2024. With slow economic expansion, the central bank had hoped to ease borrowing costs to stimulate investment and consumer spending.
Earlier in February, the Bank of England reduced its key interest rate to 4.5%, marking its first cut in a period of high inflation. However, Governor Andrew Bailey emphasised that any further reductions would be approached with caution. He stated that the bank would adopt a “gradual and careful” strategy when considering future rate cuts, ensuring that inflation remains under control while providing necessary support for economic recovery.
With inflation proving more persistent than expected, policymakers will need to carefully navigate their next steps. A premature rate cut could risk reigniting inflation, while delaying reductions for too long may further strain households and businesses already struggling with high borrowing costs. The coming months will be crucial in determining the Bank of England’s ability to steer the economy through this challenging period.
Neil Birrell, chief investment officer at Premier Miton Investors, highlighted the growing pressure on the UK economy to deliver sustained growth. He acknowledged that while there are reasons for concern, one positive takeaway is that core inflation has not worsened beyond expectations. However, despite a slight economic expansion in the final quarter of last year, uncertainty remains over whether growth is continuing into 2025.
The challenge of a stagnant economy coupled with persistent inflation is not an ideal scenario for either the government or the Bank of England. Birrell noted that policymakers face significant difficulties in finding effective solutions, as there are no simple measures available to tackle the problem swiftly. This adds further complexity to the Bank’s efforts to balance economic stability with inflation control.
The latest surge in inflation has been largely attributed to the introduction of VAT on private school fees and rising transport costs, particularly in the airline sector. In January, transport prices increased by 1.7%, reversing the 0.6% decline recorded in the previous month. These cost pressures have contributed to a higher-than-expected inflation rate, making the Bank’s job even more challenging.
Luke Bartholomew, deputy chief economist at Abrdn, pointed out that while the Bank of England has recently been more focused on weak economic growth rather than inflation risks, the latest figures may not be enough to significantly alter its policy stance. He suggested that a rate cut in March now seems unlikely, with the Bank opting to maintain its cautious approach to easing monetary policy.
Looking ahead, the speed at which interest rate cuts are implemented in the second half of the year will depend on inflation trends. If inflation moves closer to the Bank’s 2% target, a faster pace of rate reductions could become more feasible. However, financial markets have already adjusted their expectations, with the probability of a rate cut in March dropping from 24% to just 17% following the latest inflation data.
Despite the setback, markets still anticipate at least two rate cuts before the end of the year. The coming months will be crucial in determining whether inflation pressures ease enough to give the Bank of England the confidence to accelerate its plans for rate reductions.
Ruth Gregory, deputy chief UK economist at Capital Economics, has highlighted the expected rise in inflation over the coming months, largely driven by higher energy costs. She predicts that Consumer Price Index (CPI) inflation will exceed 3% over the next seven months but does not believe this will stop the Bank of England from continuing to lower interest rates.
Despite the short-term rise, Gregory remains confident that inflation will drop below 2% by 2026 as temporary pressures ease and the UK’s sluggish economy leads to lower service costs. However, she warns that if inflation remains persistently high, the Bank may be forced to slow down its rate cuts or halt them earlier than expected.
The Bank of England’s own projections suggest inflation could peak at 3.7% later this year, with energy prices, water bills, and transport costs such as bus fares playing a significant role. Governor Andrew Bailey has stressed that this inflation surge is due to external factors and does not indicate underlying economic strength.
The EY Item Club, a leading economic forecasting group, expects the Bank to maintain a cautious approach to interest rate cuts, with the next reduction likely to come in May. According to Matt Swannell, the group’s chief economic advisor, the latest inflation figures were largely in line with expectations, meaning the Monetary Policy Committee (MPC) is unlikely to change its planned approach of gradual rate adjustments.
Services inflation, a key measure watched by the Bank, rose to 5% in January from 4.4% in December. This increase raises concerns, as services inflation is often seen as a longer-term indicator of overall price stability.
Thomas Pugh, an economist at RSM UK, noted that the unexpected jump in inflation from 2.5% to 3% in January could be the beginning of an upward trend. He warns that inflation may reach 3.5% or higher by mid-2025. While he still anticipates the Bank of England will cut rates every quarter, he acknowledges that rising inflation and a weak economy could complicate this outlook.
Adam Deasy from PwC has commented on the latest inflation rise, stating that while it is unwelcome, it was not entirely unexpected by the Bank of England. He pointed out that policymakers had already anticipated this increase, particularly in services inflation.
According to Deasy, the Bank of England’s February Monetary Policy Committee (MPC) report had projected services inflation to be just above 5% for January. This reinforces the Bank’s commitment to a measured and gradual approach in easing monetary policy, ensuring that rate cuts do not come too soon or too aggressively.
He emphasised that the key issue now is timing, with a March interest rate cut looking increasingly unlikely. While today’s inflation data presents a challenge, he described it as a “speed bump” rather than a major obstacle on the path towards lower interest rates.
Roger Barker, Director of Policy at the Institute of Directors, has expressed concerns that the latest inflation figures could push back the timeline for rate cuts even further. He warned that businesses are already facing economic uncertainty, and any delay in reducing borrowing costs could add further pressure.
Barker also highlighted the risk of stagflation—a scenario where high inflation is coupled with sluggish economic growth. He stressed that January’s inflation figures have done little to ease these fears, leaving UK businesses in a difficult position as they navigate an unpredictable economic landscape.
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