Rising inflation makes a speedy interest rate cut less likely

Inflation rose to 4 per cent on the year to December, up slightly from 3.9 per cent the previous month. It’s the first time the inflation rate has increased for almost a year – an unexpected uptick, as the consensus was for the rate to slow once more, down to 3.8 per cent. 

This is not the update politicians and central bankers were hoping for, but as far as monthly data goes, it’s not the end of the world either. The inflation rate doesn’t come down in a straight line, as evidenced already in the UK’s battle to get prices under control. The jump up to 4 per cent on the year in November seems to have largely been driven by an increase in alcohol and tobacco prices, while prices that have caused some of the most pain and grievances – like food and nonalcoholic beverages – accounted for the biggest ‘downward contributions’. These slowed from 9.2 per cent on the year in November to 8 per cent in December. 

December’s rate is still notably below where the Bank of England last predicted inflation would be at that point. The Bank’s forecast estimated the inflation rate at 4.5 per cent by the end of the year; where it landed, at 4 per cent, was not predicted to be achieved until this spring.

So what does today’s update mean for the prospect of an interest rate cut? UK two-year gilts jumped this morning in light of the inflation news, as the prospect of interest rate cuts happening sooner rather than later were dampened. The concern is that external events – like the disruption to commercial shipping in the Red Sea, which makes up 15 per cent of global seaborne trade – could produce more volatile inflation figures in the coming months. Expectation is rising that the inflation rate may pick up slightly again in January, reflecting the delays to shipping, before it starts to slow again in the lead-up to April when Ofgem lowers the Energy Price Cap and last year’s higher prices fall out of the calculation. 

Independent forecasters including Oxford Economics and Deutsche Bank have been predicting a much faster return to target than is currently expected by the Bank (something closer to the second quarter this year, rather than the start of next year). Capital Economics reports this morning that despite the ‘disappointing’ rise in December, it is still predicting inflation returns to 2 per cent this spring, which should enable rate cuts to start earlier than the Bank has been indicating. 

But having already taken so many hits to its reputation by failing to get inflation under control in 2021, the Bank is going to want to be certain about its inflation data before it looks to cut the base rate. This morning’s news makes it less likely that we’ll get any such update from the Bank when the Monetary Policy Committee meets in February or March.