Surprise inflation drop gives Reeves a break as UK cost of borrowing falls

Rachel Reeves gained breathing space yesterday after better-than-expected inflation figures raised expectations for a Bank of England rate cut and reduced UK borrowing costs.

- Richard Partington

After a tough week for the government on the economy, official figures showed inflation unexpectedly cooled in December to 2.5%, down from 2.6% in the previous month, meaning prices rose at a slower rate.

Lifting some of the pressure on the chancellor as she sought to talk up Labour's growth agenda, the news sent the yield - in effect the interest rate - on UK government bonds tumbling at the fastest rate since 2023.

With 10-year gilt yields falling by almost 0.2 percentage points to about 4.7%, the sharp decline erased nearly all of the increase of the past seven days, when turmoil in the bond market had forced Reeves to contemplate spending cuts to meet her fiscal rules.

On a day of relief in global markets - after US figures showed cooling underlying inflationary pressures in the world's largest economy - economists said the latest UK snapshot had raised the chances of the Bank of England cutting interest rates when it meets on 6 February.

With the economy on the brink of stagnation, a senior Bank policy-maker warned yesterday that interest rates may need to be drastically reduced to avoid lasting damage on households and businesses.