Inflation falls to a two-year low – now will interest rates follow?

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The Bank of England is under mounting pressure to cut interest rates to help homeowners after a surprise fall in inflation gave consumers “an early Christmas present”.

Falling petrol prices helped curb inflation to 3.9 per cent, the lowest rate in two years and well below Rishi Sunak’s target of 5 per cent by the end of the year.

But leading economists told The Independent that although “the bulge has made its way through the snake”, much of the “low hanging fruit” has been picked – and the central bank will struggle to reach its longstanding target of 2 per cent.

They also warned that many homeowners coming off fixed rates now face “a very different world”, while Britain’s slowing economy and higher mortgage costs mean living standards will “remain pretty desperate”.

Signalling a change in the political tide, work and pensions secretary Mel Stride said the inflation fall could allow the Bank to ease interest rates and aid those struggling with mortgage costs. Most economists had been expecting a dip to 4.3 per cent last month.

While he emphasised its independence, the cabinet minister said that the faster-than-expected fall in inflation “does take some pressure off [the Bank] in terms of keeping interest rates higher, which of course in time and in turn feeds into mortgage rates”.

Falling prices at the pumps helped push inflation to a surprise low, which the prime minister hailed as “good news for everyone in this country”.

Inflation also slowed on things like food, air travel and the cost of a second-hand car.

With just days to go before Christmas, Simon Pittaway, senior economist at the Resolution Foundation, said that “politicians and the public can all cheer this festive surprise”.

But the rampant inflation of recent years means prices are around 20 per cent higher than they were in 2020, and economist Laith Khalaf of AJ Bell warned that food price inflation remains at a “pretty concerning” 9 per cent.

Despite the latest figures, Mr Khalaf warned that UK consumers are still “heavily under the pump” – with mortgage holders set to come off fixed deals next year “facing a different world”.

“It’s almost like another leg of the cost of living crisis,” he told The Independent. “It started off with fuel and heating, it then moved onto food. There’s rising interest rates, and don’t forget taxation as well, where over the next five years the tax burden is expected to rise to highest since the Second World War.”

Suren Thiru, economics director at the Institute of Chartered Accountants, said that the “dramatic” fall in inflation showed there was light at the end of the tunnel. But they added that “living standards will remain pretty desperate as this boost is largely offset by a squeeze on incomes from higher mortgage costs and a slowing economy.”

Labour warned that more than a million people face higher mortgage payments “after the Conservatives crashed the economy”.

Following last week’s decision by the Bank of England to hold its base rate for a third time at 5.25 per cent, economists suggest the markets are pricing in interest rate cuts by May – and perhaps as early as March – as pressure intensifies on the central bank.

“The first 25 basis point cut is now fully priced in for the Bank’s May meeting, with a decent chance of a start to cuts in March,” said Matthew Ryan, from financial services firm Ebury, while James Smith of ING bank said: “Markets are right to be pricing a number of rate cuts for 2024 … starting in May.”

Yael Selfin, chief economist at KPMG, told The Independent that, while the new inflation figures were good news “the Bank of England is likely to be quite cautious in cutting rates”.

Echoing these concerns, Rob Morgan, chief analyst at Charles Stanley pointed to the soaring prices of recent years as he said: “We’re sort of coming down the other side of [high inflation], so the bulge has made its way through the snake.

“Our worry is you’ve had the easy wins because you’ve had the energy bills coming down, fuel prices coming down quite a lot lower. It’s difficult to replicate that kind of disinflation going forward,” he added.

Citing looming increases in the national living wage and state pension, with borrowing costs and mortgage rates also starting to fall, Mr Morgan said: “It makes it difficult to get that last little bit of inflation out of the system. The low-hanging fruit for the Bank of England has been picked.”

Responding to the inflation figures, the chancellor Jeremy Hunt said the economy was back on the path to “healthy, sustainable growth”. But he acknowledged that “many families are still struggling with high prices so we will continue to prioritise measures that help with cost of living pressures”.

Shadow chancellor Rachel Reeves said the fall in inflation would come as a “relief” to families. “However, after 13 years of economic failure under the Conservatives, working people are still worse off,” she added.

“Prices are still going up in the shops, household bills are rising, and more than a million people face higher mortgage payments next year after the Conservatives crashed the economy.”