Inflation in surprise rise ‒ what it means for you

Inflation rose unexpectedly in December, new data from the Office for National Statistics (ONS) has revealed. 

The ONS found that the consumer prices index (CPI) measurement of inflation rose by 4% in the 12 months to December 2023. That’s up slightly from the 3.9% recorded in the year to November, and represents the first increase in inflation since February 2023.

Nonetheless, this is the second lowest level seen since September 2021.

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The increase in the annual rate of inflation was the result of a 0.4% increase in prices over the month, the same hike that was seen between November and December a year earlier.

While inflation remains low compared to recent levels, having peaked at 11.1% in October 2022, it is nonetheless double the 2% target for inflation which the Bank of England employs.

As a result there will likely be further discussion around whether the Bank of England is right to keep the base rate at 5.25%, having frozen the base rate at its last few meetings of the Monetary Policy Committee (MPC).

That will have implications for mortgage holders and those looking to buy a property, who have seen their costs escalate, but also for savers who have seen a succession of providers strip back the best savings rates available.

Jill Mackay, savings specialist at Scottish Friendly, said the figures show how difficult it is to “tame UK inflation at the moment”, but that the hope is “the worst of the UK’s inflationary detour in 2023 is behind us”.

WHY HAS INFLATION RISEN?

The costs of alcohol and tobacco were a big factor in the rise in inflation, according to the ONS. 

Prices rose by 12.8% in the year to December 2023, up from the 10.2% rise in the year to November. The ONS suggested this was largely down to the increase in tobacco duty, which was announced in the Autumn Statement.

Another contributor was recreational and cultural goods and services, where prices rose by 0.2%, compared with a 0.2% fall from a year ago.

The ONS said that this came from price changes in products like DVDs, computer software, theatre admissions and package holidays.

There was also a marginal contribution from transport costs, and specifically air fares, which traditionally see an uplift at this time of year.

WHAT DOES THIS MEAN FOR INTEREST RATES? 

Over the past couple of years inflation has been far higher than the Bank of England would like, and that has driven repeated increases to the bank base rate. Back at the start of 2023, the base rate stood at 3.5%, but it is now set at 5.25%.

However, as inflation has fallen of late, the Bank of England has instead opted to freeze base rate at its last few meetings. This hasn’t been unanimous ‒ some members of the committee have called for further increases ‒ but the majority have been in favour of keeping base rate at its level, in the belief that inflation is heading in the right direction.

Indeed, thoughts have instead turned to when the base rate will be cut, though this may now be thrown into doubt given the surprise increase in the year to December.

Alice Haine, personal finance analyst at Bestinvest, said: “The surprise inflation rate rise puts a bump in the road for the path towards interest rate cuts, something many forecasters were expecting to happen sooner rather than later this year.”

Rob Clarry, investment strategist at Evelyn Partners, said that with CPI still expected to decelerate ‒ in part down to energy prices dropping ‒ the prospects for base rate reductions are good.

“Traders now expect around five interest rate cuts in 2024, with the first coming in May. Although they have rowed back on their expectations at the start of the year when they priced in six cuts for the year,” he explained.

This was echoed by Julian Jessop, economics fellow at the Institute of Economic Affairs, who argued that the “big picture” has not changed.

“There will be six MPC meetings between May and December, leaving plenty of time for the Bank to cut rates from the current 5.25% - perhaps to around 4% by the end of the year.”

WHAT DOES THIS MEAN FOR BORROWERS AND SAVERS?

The expectation that base rate has peaked has had an impact on borrowers and savers alike. A host of mortgage lenders have reduced the rates on their products since the turn of the year, with lower rates prompting those would-be buyers who put their plans on hold to return to the market.

Haine said the figures would “come as a blow for mortgage holders and prospective buyers

waiting on tenterhooks for interest rate cuts to soften the blow from high mortgage rates”, though pointed out that borrowers have far greater levels of choice today than was the case just a few months ago.

Similarly, the anticipation of rates being reduced has played out for savers, with a succession of providers cutting the returns on offer. Last week for example NS&I cut the prize rate on Premium Bonds. As a result, savers have felt the need to move quickly in order to get the best rates available while they still can.

But Sarah Coles, head of personal finance at Hargreaves Lansdown, suggested this surprise rise “could mean we get a pause in the cuts, and there’s a chance some of the better deals could go sooner rather than later, so if you are in the market for a fix, it’s worth acting as soon as it makes sense for you".

WHAT DOES INFLATION MEAN FOR MY HOUSEHOLD BILLS?

The January inflation data is also relevant for a host of household bills.

Many broadband and mobile phone providers impose price increases each April in line with inflation, and use the January inflation figure when doing so.

This is typically the inflation figure plus around 3.9%, so many people will see their bills rise by around 7.9% from the start of the new tax year.

Alex Tofts, broadband expert at Broadband Genie, said: “This will come as unwelcome news for consumers struggling with rising living costs. Each provider determines their price increase based on their chosen metric. In recent years, the unpredictable and volatile nature of inflation means broadband customers are in the dark about future price rises before signing up to a contract.”