UK Inflation Drops Sharply Boosting Prospects for Early Interest Rate Cuts

The UK inflation rate has decreased significantly to 3 per cent in January, raising hopes for an early reduction in interest rates by the Bank of England. This figure, which aligns with a majority of economists’ predictions, marks its lowest level since March 2025.

The Office for National Statistics reported that the decline was primarily driven by falls in petrol prices, air fares, and food costs. Notably, the rise in prices for food and non-alcoholic drinks has slowed sharply to 3.6 per cent in the year to January, down from 4.5 per cent in December. This represents a nine-month low.

The average price of petrol fell by 3.1 pence per litre between December and January, now standing at 133.2 pence per litre, while diesel has decreased by 3.2 pence to reach 142.5 pence per litre. Inflation had peaked last year at 3.8 per cent, with economists generally expecting a rapid return to the Bank’s target of 2 per cent.

The latest figures indicate a strong possibility of a rate cut as early as March, driven by concerns among policymakers regarding the slowing pace of economic growth. Markets indicate an 86 per cent likelihood of a reduction in the interest rate to 3.5 per cent in next month’s meeting, compared to 77 per cent prior to the release of the inflation data.

Grant Fitzner, the chief economist at the ONS, noted that along with petrol prices, air fares contributed to the downward trend in inflation this month. Lower food prices have been particularly beneficial, especially for bread, cereals, and meat. However, these reductions were partially offset by rising costs in hotel stays and takeaways.

Core inflation, which excludes more volatile items such as energy, food, and alcohol, also decelerated to a rate of 3.1 per cent for the year to January, compared to 3.2 per cent in December. While services inflation, which encompasses consumer-facing services like hospitality and entertainment, only marginally decreased to 4.4 per cent from 4.5 per cent in December, remaining above the Bank’s forecast of 4.1 per cent.

The country’s economy has experienced a growth rate of merely 0.1 per cent in the three months leading to December. Meanwhile, the unemployment rate has risen to a five-year high of 5.2 per cent, according to official statistics. Private sector earnings increased by 3.4 per cent over the year to December, a slight decline from the 3.6 per cent growth recorded in November.

The chancellor, Rachel Reeves, has expressed optimism about the inflation figures, which support her efforts in the November budget to alleviate living costs, primarily through reductions in energy bills and rail fares. Projections suggest that these measures will contribute to a further decrease in the consumer price index in April.

Economists anticipate that a combination of government initiatives and reduced wholesale gas prices could enable household energy bills to drop by approximately 7 per cent starting in April. Recent declines in global food prices are expected to be passed on to UK consumers, aiding further reductions in inflation.