A Christmas miracle? Inflation slows to 3.9%

The rate of inflation has dropped again - does this mean an interest rate cut is coming?

Young woman shopping vegetables in supermarket
(Image credit: Oscar Wong)

Inflation has fallen to its lowest level for more than two years, raising hopes of an interest rate cut early in the new year.

Office for National Statistics data released this morning shows the rate of inflation slowed to 3.9% in the 12 months to November.

It comes after the inflation rate fell to 4.6% in October from 6.7% in September.

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It takes the inflation rate closer to the Bank of England’s 2% target, raising confidence that interest rate cuts could come as soon as March 2024.

The move will be welcomed by mortgage holders or potential borrowers hoping for rates on home loans to drop but savers could see more top savings rates disappear from the market.

While the rate is slowing, it does still mean prices are rising - but maybe not as fast. Food costs remains high while core inflation, which strips out volatile prices such as energy and food, is 5.1%. 

Why has inflation dropped?

One of the main factors pushing inflation down has been falling fuel prices.

The ONS said the average price of petrol fell by 4.1p per litre between October and November 2023 to 151p per litre. Diesel prices fell by 3.2p per litre this year to 159p per litre.

These movements resulted in overall motor fuel prices falling by 10.6% in the year to November 2023, compared with a fall of 7.6% in October, the ONS said.

Lower costs for second-hand cars, maintenance and repairs and air fares have also pushed inflation lower, added the ONS.

Prices for recreational and cultural goods and services such as toys and games fell by 0.4% between October and November this year, possibly helped the Black Friday and Cyber Monday sales - the lowest since March 2023. 

Meanwhile, food and non-alcoholic beverage prices rose by 0.3% between October and November 2023, compared with a rise of 1.1% a year ago. The annual rate was 9.2% in November 2023, the lowest since May 2022. 

"The fall in headline inflation to 3.9% marks a dramatic and unexpected fall in UK inflation. While we're still seeing prices rise faster than the US and Europe, the UK is no longer the outlier it once was. 

“Lower rates of food and drink inflation, cheaper games and toys and lower fuel costs will have been a welcome Christmas miracle for cash strapped families ahead of the festive period, and retailers will welcome a flusher consumer too,” says Nicholas Hyett, investment analyst at Wealth Club.

“However, like any Christmas miracle the main character's actions are only passingly relevant to the outcome."

He highlights that the fall in inflation has been driven largely by lower oil and gas and food prices, with core inflation still high at 5.1%. 

"Commodity prices aren't something governments or even central banks have much control over - and until core inflation, reflecting things like domestic pay rises, is back closer to target we suspect the Bank of England will remain cautious on interest rates," Hyett adds. 

He highlights that prices are still rising faster in the UK than in the US and Europe.

“With inflation now at its lowest level in over two years, it feels like the worst may now be behind us,” he adds.

“Unless and until the febrile geopolitical environment sends oil prices soaring once again of course.”

What does lower inflation mean for interest rates?

Inflation has fallen faster than expected, which may prompt the Bank of England to cut interest rates sooner but the cost of living measure remains above the 2% target.

Slowing inflation and the prospect of an interest rate cut could also bring mortgage pricing down and boost the property market.

There’s growing confidence cuts to the base rate could begin as early as March and that by this time next year the economic landscape will look very different – more than one in 10 are now betting rates could fall back to below 4% by next December,” says Danni Hewson, head of financial analysis at AJ Bell.

“With around 1.5 million homeowners whose fixed rate mortgages are up for renewal in 2024, these numbers are likely to further increase competition amongst lenders to offer better and better deals.”

There may also be a temptation for savings providers to lower rates now that inflation has dropped further.

Dean Butler, managing director for retail direct at Standard Life, added that savers will need to act fast to grab the top savings deals.

 “Now is the time to act and shop around for the accounts paying the best interest rate suited to their needs,” says Butler.

“There are quite a few easy access cash-based savings accounts currently offering inflation-busting rates, giving savers the chance of seeing real returns on their cash savings for the first time in many years – and it’s possible we’ll see rates fall before too long.”

James McManus, chief investment officer at Nutmeg, says there are still some sticky elements to inflation that may delay an interest rate cut.

“Headline inflation needs to halve yet again, if it’s to get close to the Bank of England’s illusive 2% target,” he says.

“A drop from 4% to 2% could be tougher to achieve than the bigger drop we’ve already seen, given some of the more sticky elements. "

While energy prices are well below last year’s levels, McManus highlights that food prices are still 9% higher than a year ago.

"Food inflation – perhaps one we all feel most acutely in our weekly shops or eating out bills – still needs to come down dramatically," he adds.

“Services inflation is another key watch out for the Bank of England, with rising wages and a strong labour market.

“One final problem area for core inflation the UK is semi-durable goods, such as clothing.

“Together with the wages picture, there is plenty for the Bank of England to chew over on the inflation front.”

Marc Shoffman

Marc Shoffman is an award-winning freelance journalist specialising in business, personal finance and property. His work has appeared in print and online publications ranging from FT Business to The Times, Mail on Sunday and The i newspaper. He also co-presents the In For A Penny financial planning podcast.