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UK inflation rose unexpectedly in December for the first time in 10 months, causing gilt yields to rise and traders to scale back expectations of how soon the Bank of England will start cutting interest rates.
Consumer prices rose at an annual rate of 4 per cent in December, up from 3.9 per cent in November, the Office for National Statistics said on Wednesday.
The reading — double the BoE’s inflation target — was driven by increases in alcohol and tobacco duty and exceeded the 3.8 per cent forecast by economists in a Reuters poll.
The figure marked the first increase in price rises since February last year and led traders in the swaps market — which reflects predictions of the future level of BoE interest rates — and some economists to scale back expectations for rate cuts this year.
“The data today will make the BoE’s Monetary Policy Committee more cautious,” said Tomasz Wieladek, chief European economist at investment company T Rowe Price. “We could see rate cuts at a pace of once per quarter rather than once per month.”
Interest rate-sensitive 2-year gilt yields rose 0.11 percentage points to 4.27 per cent. Benchmark 10-year gilt yields rose 0.09 percentage points to 3.89 per cent, the highest level since December 13.
The market-implied probability of the first interest rate cut coming in May fell to 55 per cent, from more than 80 per cent ahead of the ONS figures. Traders are pricing 1.12 percentage points of cuts in 2024, down from 1.24 percentage points earlier on Wednesday.
The BoE’s benchmark rate stands at a 15-year high of 5.25 per cent, after the central bank lifted the cost of borrowing in a bid to tame high inflation since late 2021.
Services inflation, which is closely monitored by policymakers as a better measure of domestic price pressures, accelerated to 6.4 per cent in December from 6.3 per cent in November.
Core inflation, which excludes food and energy prices, was 5.1 per cent in December, unchanged from the previous month. Analysts had expected it to fall to 4.9 per cent.
Thomas Pugh, economist at audit firm RSM UK, said the uptick in consumer prices, together with the rise in services price growth, would “probably be enough to quash any temptations at the MPC to start to change tone at its meeting in February”.
The unexpected rise in headline inflation follows two months of sharp declines and mirrors similar upticks in inflation in the US and the eurozone.
In the eurozone, headline price growth increased to 2.9 per cent in December from 2.4 per cent in the previous month. It increased to 3.4 per cent from 3.1 per cent in the US over the same period.
Chancellor Jeremy Hunt said: “As we have seen in the US, France and Germany, inflation does not fall in a straight line, but our plan is working and we should stick to it.”
“We need to stay the course we have set out, including boosting growth with more competitive tax levels,” he added.
In a boost to households, food inflation eased to 8 per cent in December, down from 9.2 per cent in the previous month and the lowest rate since April 2022.
Food inflation hit a 45-year high of 19.2 per cent in March, hitting the poorest households the hardest since they spend a bigger share of their income on essentials.
Grant Fitzner, ONS chief economist, said: “The rate of inflation ticked up a little in December, with rises in tobacco prices due to recently introduced duty increases.”
He added that “these were partially offset by falling food inflation, where prices still rose but at a much lower rate than this time last year”. There were also material upward contributions from recreation, airfares and clothing.
Despite the uptick to 4 per cent in December, price growth was still below the BoE’s latest forecasts.
In its most recent monetary policy report, the central bank predicted headline inflation of 4.6 per cent, and services inflation of 6.9 per cent, in the final two months of 2023.
Most economists expect UK inflation to accelerate this month, in part of because of base effects, which are set to boost the annual pace of change in prices compared with data for January 2023.
Despite risks to the outlook, spanning the disruption to shipping in the Red Sea to the impact of possible tax cuts in the Spring Budget, many analysts forecast the downward trajectory will resume from February with large drops in the spring, helped by base effects and lower gas prices.
Ruth Gregory, deputy chief UK economist at Capital Economics, said that although the rise in inflation in December was “disappointing”, the research company expected “favourable base effects and a fall in utility prices to drag CPI inflation below the 2 per cent target by April, leaving the Bank of England in a position to cut interest rates by June”.
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