That concludes our preview analysis for today. We will be back in the same place tomorrow, bright and early, to cover the inflation news as it breaks at 7.00am. Thank you for joining us.
Base rate cuts: is market pricing realistic?
Having shared some analysis on what the latest developments mean for your personal finances, let’s return to the UK economy and the outlook for interest rate cuts.
Markets are currently pricing in just 50 basis points of cuts this year – but is that realistic?
“This may sound conservative, but with inflation at 2.6% and services inflation being somewhat sticky, the BoE may not be able to lower rates more than this without upsetting the balance,” says Michael Field, European strategist at Morningstar.
“Markets usually start off overly optimistic at the beginning of the year, and then slowly adjust expectations downwards as the year progresses. However, this time around it appears we might have a realistic number from the off,” he adds.
What do higher inflation expectations mean for bond investors?
If you are invested in a bond fund, you might have noticed some losses in recent weeks as a result of the selloff. Investors have been selling out of the market in response to inflation fears (inflation is a bond investor’s nemesis). There is also a lack of confidence in the UK economy after the Budget.
As a result, the government is now having to pay more to borrow money. Bonds also become less attractive on the second-hand market when new issuances come with higher coupons, so their price falls.
The silver lining is that higher yields have created new income opportunities. This could create buying opportunities – but remember that markets are notoriously difficult to time.
“You might think that yields could go higher, and you might want to try to time the peak in yields. That’s difficult to do and markets can move quickly, so it could backfire if yields suddenly reverse their current trend,” Streeter says.
What about annuity rates?
Annuity rates have surged too – a positive development for those thinking about buying a guaranteed income in retirement.
“The latest data shows a 65-year-old with a £100,000 pension can now get up to £7,425 a year from a single life level annuity with a five-year guarantee,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.
“This is up from £7,235 a year last week and up a whopping 48% on the £5,003 that was on offer this time three years ago,” she adds.
What does it mean for your personal finances?
Mortgage rates have increased slightly in recent days in response to the volatility in bond markets. Mortgage rates are closely linked to gilt yields, which have surged higher in response to new inflation risks. The average two-year fixed mortgage rate is now 5.49%, according to Moneyfacts. The average five-year rate is 5.27%.
The savings market hasn’t moved dramatically, but the latest developments have helped to normalise the market “with fixed-term bonds finally offering more interest than easy-access accounts,” says Mark Hicks, head of active savings at Hargreaves Lansdown.
What’s next for UK interest rates?
In recent weeks, markets have been adjusting to the realisation that interest rates could stay higher for longer. It is unsurprising given inflationary risks have picked up – think higher energy prices, UK Budget fallout, and Trump’s tariffs. Gilt yields have surged as a result, creating a real headache for Reeves.
There are still several factors at play, though. If Reeves is forced to cut spending or raise taxes further (an attempt to balance the books in light of higher borrowing costs), it could dampen UK growth.
Tariffs from Trump could also have a negative impact on UK GDP, if production slows as a result of supply chain disruption.
In Streeter’s view, a scenario like this could prompt the Bank of England to cut interest rates a little faster than markets are currently expecting. Indeed, it is worth remembering that the Bank of England has a dual mandate. As well as controlling inflation, it is responsible for supporting economic growth.
Markets are now forecasting fewer rate cuts in 2025 than previously expected. Are they being overly bearish?
Airfares and hotel costs “weaker” in December
Deutsche Bank’s chief UK economist Sanjay Raja says airfares and hotel costs probably weakened in December. This could contribute to a slowdown in the rate of services inflation. This is good news for consumers looking to book a flight or UK getaway. It is unlikely to mean much to the Bank of England, though.
In their extensive analysis on services inflation, the economists at ING have pointed out that some categories matter less than others. Air fares (which are notoriously volatile) are one such example.
Based on this analysis, the group has created its own metric – “core services inflation” – which strips out certain items. The good news is that ING expects this measure to get close to 3% this spring when things like phone and internet bills come down.
Energy prices could surge higher in the spring
Although services inflation could slow down in the spring, the tug of war between different parts of the basket will continue. Energy prices are expected to rise further, for example.
The latest forecast from consultancy Cornwall Insight suggests the Ofgem price cap could surge by as much as 3% in April. Experts are blaming geopolitical instability, price cap reforms, and uncertainty over US liquified natural gas exports under a second Trump presidency.
Energy bills are expected to rise again in the spring, after surging 10% in October and 1.2% in January
Outlook for services inflation
It is possible that services inflation will experience a meaningful slowdown this spring.
As the economists at financial institution ING have pointed out, a large part of the services basket is affected by annual changes in index-linked prices. This includes things like your phone and internet bills. Price hikes generally come into play in March or April, and are often tied to CPI or RPI.
As the overall rate of inflation is considerably lower now than a year ago, bill hikes this year are likely to be less dramatic than last year. This should feed through to the headline services inflation figure.
Why is services inflation so important?
As introduced previously, the services sector is the biggest part of the UK economy. As a result, tracking price changes in this area can help us understand how embedded inflationary pressures are on a domestic level.
The Bank of England wants to see further disinflation in the services sector before cutting rates dramatically. Services inflation is still coming in quite hot.
Governor of the Bank of England, Andrew Bailey
Where are core and services inflation heading?
Both core and services inflation are closely watched by the Bank of England.
Core inflation strips out volatile categories like energy, food, alcohol and tobacco, which allows it to give a more stable picture of the long-term inflation trend. Meanwhile, services inflation tracks price changes in the services sector, which accounts for around 80% of the UK economy.
Deutsche Bank expects core inflation to come in at 3.48% tomorrow, and services inflation to come in at 4.86%. These figures would be rounded to 3.5% and 4.9% by the ONS. This would leave core inflation unchanged compared to November (3.5%), but would constitute a downward movement for services inflation (5%).
What is the difference between CPI and RPI?
CPI is the official measure of inflation monitored by the Bank of England, but another widely-quoted measure is the Retail Prices Index (RPI). RPI used to be the UK’s official measure until 2003. It tends to track higher than CPI because it includes costs associated with home ownership.
Where RPI does still have relevance is when it comes to setting cost increases for some bills and services. For example, it is used by the government to set annual rail ticket price increases. It is also used to set levies like road tax. Your phone and internet bills could well be linked to RPI too.
RPI came in at 3.6% in November. December’s figure will be released alongside the latest CPI figures tomorrow.
What has Trump got to do with UK inflation?
Longer term, economists have warned that policies from the incoming president could push global inflation higher. Let’s take a closer look at how US policies and UK economics are linked.
“US exporters are likely to be hit by higher tit-for-tat duties if Trump introduces widespread tariffs. It’s likely that a fresh round of trade wars will be inflationary as the higher tariffs feed through to higher prices,” says Streeter.
Indeed, many UK businesses operate globally, importing and exporting goods. If tariffs disrupt international supply chains, it will almost certainly result in higher costs for businesses, which may be passed on to customers in turn.
Tariffs could also result in a stronger dollar, which would add to inflationary woes. “Many imports bought on wholesale markets are priced in dollars,” Streeter explains, “which will be more expensive if the greenback takes on more muscle”.
President-elect Donald Trump will be sworn into office on 20 January and has previously threatened to impose tariffs from "day one"
What is the long-term inflation outlook?
The Office for Budget Responsibility (OBR) has said it expects inflation to average out at 2.6% in 2025. It then expects it to fall to 2.3% in 2026, 2.1% in 2027, 2.1% in 2028 and 2% in 2029.
These OBR figures were published alongside the Autumn Budget in October, but could change if factors on the global stage cause increased geopolitical volatility. Upside risks include Trump’s potential tariffs and an escalation in the Middle East.
Reeves is currently in Parliament, where she is being challenged on the gilt market crisis and her decision to continue with a trip to China last week. Read the latest analysis on our gilt market blog.
Consumer Prices Index
To (mis)quote Shakespeare, the course of disinflation never did run smooth.
Inflation has fallen considerably from its peak – what’s next?
The rate of UK inflation has slowed considerably from its peak of 11.1%, reached in October 2022. However, new pressures now loom large on the horizon.
For example, employer National Insurance contributions will rise in April after changes announced in the Autumn Budget. The National Living Wage will also rise by 6.7%. Many businesses are planning to pass these higher staffing costs on to customers by putting their prices up.
Wide-ranging tariffs could also be imposed by incoming president Donald Trump if he follows through on his threats. This could disrupt supply chains, creating further costs for businesses.
Inflation forecast
Economists at Deutsche Bank expect inflation to come in at 2.68% in December, which would be rounded up to 2.7% by the Office for National Statistics (ONS).
Experts at Hargreaves Lansdown also expect the headline figure to inch up.
“Prices at the pumps ticked higher over the month, while food price inflation jumped to 3.7% in December, the highest level since March,” says Susannah Streeter, head of money and markets at the investment platform.
Not all experts agree though. Morningstar has indicated the figure is more likely to remain flat at 2.6%, based on FactSet consensus estimates.
Good afternoon, and welcome to MoneyWeek’s inflation live blog. This is Katie Williams and Dan McEvoy, reporting live ahead of tomorrow’s report.
It has been a whirlwind start to the new year for the UK economy. Just two weeks into January, higher inflation expectations have caused government bond yields to surge, prompting a crisis in the gilt market.
Some are even calling for chancellor Rachel Reeves to step down – although opinions diverge on whether the Autumn Budget or political developments in the US are more to blame.
Will there be better news tomorrow?
Reeves returned from a trip to China yesterday and is expected to address Parliament after 12.30pm today