The UK is facing a fresh economic challenge as official figures released this morning show inflation rising to its highest level in 10 months, reaching 3% in January. Contributing factors include soaring plane fares, food prices, and significant hikes in private school fees, all adding pressure to households already grappling with the cost of living. Leading industry experts have offered their insights into what this means for both consumers and businesses.
Rob Morgan, Chief Investment Analyst at Charles Stanley said “It’s unwelcome news for households struggling from the upswing in the cost of living in recent years, although the resilient wage growth that continues to fan the inflationary flames is at least putting more money in the coffers to help counteract the effect.
Will inflation increase or decrease from here?
Referring to short term inflation at the last MPC meeting Governor Bailey stated that “There will be a bump in the road, but we don’t think that bump is going to have a lasting effect.”
The bump might be a little larger than anticipated. Although January’s figure is inflated by some one-offs, the picture could worsen once increases to employers’ costs take effect in April.
Some businesses will err towards passing on NIC and minimum wage rises through price increases rather than reducing headcount. This could push up services inflation and create problems for the Bank of England, which is hoping to cut rates further owing to the increasingly bleak growth picture.
The Budget measures could have some deflationary impacts too, though. With Christmas festivities behind us and higher employment costs still to come through, there could be a weakening in the jobs market with higher vacancies and easing wage pressures. This is likely to lead to a drop off in demand.
Then there are the international factors at play. The gas price could fall in the wake of any peace deal in Ukraine, which could have a beneficial impact in terms of both suppressing inflation and boosting growth. Lower energy prices would provide the Bank of England more room to lower interest rates, and this could further boost activity.
However, the threat of looming US tariffs could cloud over this ray of hope, though the UK may be better insulated than Europe given its limited goods exports. It may therefore enjoy a peace ‘dividend’ while escaping the worst of any trade wars.
When will interest rates be cut further?
Given the wide array of moving parts there is considerable uncertainty around to what extent inflation remains a problem. This is reflected in the wide range of views among policymakers at the BoE regarding the pace and extent of cuts to come.
For now, the bias will be to gently cut rates further. The BoE’s mindset has now shifted to avoiding a potential policy mistake of waiting too long. We should therefore expect a further 0.25% cut by May as it sticks to its “gradual and careful” approach for the time being.
That said, the UK should be better insulated given its limited goods exports to the US so is uniquely positioned to benefit from Ukrainian peace without the negatives of additional tariffs.
The UK has been experiencing an unenviable mix of stubborn inflation, driven by services prices and energy costs, and economic stagnation – or ‘stagflation’.
This has been reflected in the weak performance of gilts in recent weeks as markets fret about the persistence of globally and locally generated inflation pressures, combined with the government’s spending and borrowing plans and a lacklustre growth picture.
The recent spike in gilt yields, the benchmark for government borrowing costs, will have set alarm bells ringing in the Treasury. Yet Chancellor Reeves may be offered a ray of hope. With inflation falling nearer to target and financial conditions posing downside risks for the UK economy, the Bank of England should now be able to deliver greater interest rate cuts than has been discounted. This stands to ease the pressure on consumers and businesses later this year and may help take the heat out of spiralling government debt costs.
What does today’s inflation data tell us?
Today’s inflation data shows that after receding for much of 2024, average price rises moved slightly higher into the year end as CPI recorded an annual increase of 2.5% in December, which followed an increase of 2.6% in November – ahead of the Bank of England’s 2% target but still consistent of a wider trend of easing inflationary pressure.
Encouragingly, core inflation, which strips out volatile elements such as fuel and food, fell back to 3.2% in December from 3.5% a month earlier. Services inflation, which has been the hardest nut to crack for the BoE, dropped to 4.4% from 5.0% and will be of particular interest to policymakers in Threadneedle Street as they eye further possible rate cuts. Services inflation driven by wage rises has been one of the main barriers to easing monetary policy further.
When will interest rates be cut further?
Fiscal policies unveiled in the Budget, notably the increase to employer national insurance, stand to add to upward pressure on prices and mean services inflation may be hard to flush out of the system owing to its typically higher labour intensity.
Other factors could also conspire against there being more than a couple of interest rate cuts this year. Major retailers have warned that food prices may resume an upward trajectory, and a recent increase in the previously subdued oil price could herald a further inflationary pulse on top of the expected impact of Donald Trump’s reprise as US President. There are concerns that should Trump look to implement his tariff-led approach there could be a significant impact on the costs of global trade.
However, with just two cuts last year and economic pressures mounting, we believe a balance of policymakers will decide it is appropriate to take a further 0.25% slice off interest rates from 4.75% to 4.5% at the next meeting in February. If anything, the recent tightening in financial conditions, which pose clear downside risks to the UK economic outlook, reinforce the case for BoE easing in the spring too. Further reassuring inflation numbers would also serve to point the committee in that direction.
What does it mean for borrowers and savers?
Many households and businesses will be hoping for significantly lower interest rates to reduce borrowing costs. Owing to the uncertain trajectory of inflation the best they can hope for is a slow and steady downward trend, but there is a good chance market expectations will shift to more than a couple of cuts for 2025 which could provide a bit of relief in coming months.
Meanwhile, the interest rate picture remains positive for savers with the best easy access rates still north of 4.5%. However, this inflation-beating rate of return is likely to narrow over time as the base rate moves lower. It may therefore be a good time to consider a fixed rate if you are happy to lock your money away because inflation and interest rate expectations may now fall back a little. A rate of around 4.5% is currently achievable for a one-year fixed term.
Mike Randall, CEO at Simply Asset Finance said: “With business costs already at a notable high, an increase in headline inflation will further squeeze UK SME margins as they look for avenues to grow in 2025.
“As many businesses now prepare for an increase in National Insurance and Living Wage costs in April, mitigating cost pressures while unlocking their success will rely on creating a clear roadmap to fuel their growth.
“Infrastructure investment plays a crucial role in supporting the future of these businesses, but so far, the Chancellor’s recent speech on growth and infrastructure has done little in the way of immediate support. With 19% of SMEs planning to invest in their business this year following greater clarity in the Autumn Budget, government initiatives and funding to boost SME productivity will be crucial in unlocking economic potential
Neil Rudge, Head of Banking for Commercial at Shawbrook, said: “The uptick in inflation this January will be disappointing for SME leaders already grappling with significant challenges—including a stagnant economy and the upcoming increase in employer NICs this April. These pressures, combined with uncertainty around potential tariffs for businesses trading internationally, create a volatile landscape that makes planning increasingly difficult.
“On a more positive note, the Bank of England’s recent interest rate cut signals a shift towards a more supportive borrowing environment for SMEs. With expectations of gradual, continued reductions, this provides businesses with greater confidence in their financial planning. However, an uptick in inflation could disrupt these expectations, potentially delaying further cuts and impacting business confidence. In such a challenging economy, having a trusted lending partner that offers flexible solutions is crucial, ensuring businesses have the support they need to navigate uncertainty and seize growth opportunities.”
George Lagarias, Chief Economist at Forvis Mazars commented: “Inflation returning to 3% should, oddly, not be too alarming. The Bank of England tends to dismiss energy and food cost spikes, which contributed the most towards price rises, and prefers to monitor the more “sticky” parts of inflation, like wages. Yesterday, despite higher wages, Andrew Bailey was optimistic about containing wage growth going forward. If food and energy price spikes don’t repeat too often, which would suggest a problem in supply chains due to global policy uncertainty, then last month’s inflation number will likely not deter the BoE from cutting rates going forward.”
Aman Parmer, Head of Marketing at Bizspace said: “This morning’s figures will be both surprising and unwelcome in equal measure as far as small business owners are concerned. Rises in inflation often result in increased operational costs and a demand for higher wages from employees for companies of all sizes, but can weigh even more heavily on the shoulders of smaller organisations.