Consumer price inflation (CPI) in the UK surprised markets by rising to 3.4 percent in the year to December, up from 3.2 percent in November. This reading marked the first increase in headline inflation in several months and exceeded many expectations that price growth would continue its steady descent toward the Bank of England’s 2 per cent target. The uptick was driven in part by higher costs for travel and transport, including a sharp rise in airfares over the holiday season, as well as increases in the price of alcohol, tobacco and everyday goods such as bread and cereals. Food inflation itself edged up, adding to the sense that inflationary pressures had paused their earlier decline.
Although the headline rate moderated from the higher peaks seen earlier in the year, the rise to 3.4 percent underscores that inflation in the UK remains stubbornly above target, even as underlying pressures show signs of easing. Core inflation measures, which strip out volatile components such as food and energy, were broadly stable, and services sector inflation – a key gauge of domestically generated price pressures – moved only modestly. Many economists interpret the December jump as a temporary aberration caused by seasonality and one-off pricing effects rather than a sustained acceleration in broader price trends. Nonetheless, the increase complicates the inflation story for households and businesses who have grown accustomed to a more predictable downward path for living costs.
The persistently elevated inflation figure has fuelled fresh debate over the future path of UK monetary policy. Prior to the release of the data, many market participants and analysts had been anticipating that the Bank of England might begin trimming its benchmark interest rate early in the year. Earlier in 2025 the Bank had lowered its policy rate to 3.75 per cent, the lowest level in several years, and markets were tentatively pricing in further cuts as inflation looked to be on a downward trajectory. Higher inflation, however modest, changes the policy calculus.
In response to the December inflation surprise, several major financial institutions revised their forecasts for when the Bank of England is likely to reduce interest rates again. One notable example is Morgan Stanley, which had previously expected a rate cut as early as February but now projects that the next reduction in the Bank’s base rate will come in March instead. Analysts at Morgan Stanley have cited the stronger-than-expected inflation print as a key reason for pushing back the timing of a rate cut, while still anticipating subsequent reductions later in the year as inflation pressures ease further. Their updated expectations include potential quarter-point cuts in March, July and November, reflecting a view that although price pressures remain elevated in the short term, they will continue to ease through 2026.
From an economic standpoint, the inflation uptick and the shifting outlook for interest rates highlight the delicate balance facing UK policymakers. On one hand, households and businesses continue to feel the pinch of higher prices on essentials like food and transport, making reductions in borrowing costs politically and socially appealing. On the other hand, prematurely lowering interest rates while inflation remains above target risks embedding higher price expectations and delaying a return to price stability. The Bank of England’s Monetary Policy Committee will need to weigh these competing forces carefully in the months ahead, particularly as the labour market and broader economic growth dynamics evolve.
For financial markets, the December inflation data has already had a noticeable impact. Traders and investors adjusted their expectations for the timing and magnitude of future rate moves, tempering bets on imminent monetary easing and recalibrating the outlook for UK assets accordingly. Sterling has shown some resilience, partly reflecting the perception that the Bank of England may maintain tighter policy for longer than previously thought, even if rate cuts remain likely later in the year.
For consumers and businesses, the modest rebound in inflation serves as a reminder that the path back to the Bank of England’s 2 per cent target is unlikely to be smooth or linear. While policymakers and economists broadly expect inflation to continue its downward trend as temporary factors fade and core price pressures weaken, the December figure underscores the complexity of managing an economy still adjusting to post-pandemic shifts, global price volatility and changing demand patterns. As 2026 unfolds, upcoming inflation releases and Bank of England decisions will be closely watched for clearer signals on the trajectory of UK prices and monetary policy.