Inflation fell marginally last month, to 2.5% from 2.6%, lower than some expectations, but the outlook for interest rate cuts remains uncertain.

Core inflation, which strips out more volatile components like food and energy, dipped to 3.2%, down from 3.5% previously and also below expectations.

However, increases in national insurance contributions and the living wage from April will lead to price rises on a range of products, not least in retail and hospitality.

This may temper the Bank of England’s next moves on interest rates. A cut had been pencilled in for next month, but rate-setters are on alert for signs of upward pressures on prices and wages.

The British Retail Consortium said 67% of 52 chief financial officers it surveyed fsaid they would raise prices due to April’s rise in employer contributions, while some, including Sainsbury’s and Greggs, have agreed to wage rises for staff.

Even so, today’ data has heightened expectations of a base rate cut on 6 February. Markets were pricing in a 62% chance of a cut to 4.5% from the current 4.75%. This has now risen to 74%. Markets still expect just two cuts this year against as many as four predicted by some commentators.

The latest figures from the Office for National Statistics may also ease concerns over the public finances and government borrowing costs hitting their highest level for several years.

Prime Minister Sir Keir Starmer said he is prepared to be “ruthless” on spending cuts to make sure the government remains within its fiscal rule that will balance the books.

Opposition parties have claimed this heralds a new phase of austerity while business groups in particular say a clampdown on spending in government departments will cut out waste, duplication and over-regulation that will help release funds for frontline services and contribute to growth.

Commenting on today’s inflation figures, the CBI’s principal economist Martin Sartorius, said: “Inflation remained moderately above the Bank of England’s 2% target in December, reflecting the impact of ongoing price pressures such as strong wage growth.

“Looking ahead, we expect inflation will stay elevated this year, partly due to Autumn Budget measures contributing to higher prices.

“Persistent, above-target inflation supports our expectation that the Monetary Policy Committee will loosen policy at a gradual, quarterly pace throughout 2025.

“The next rate cut is still likely to come in February, which will bring some respite for businesses and households as they continue to face high borrowing costs.”

Nicholas Hyett, investment manager, Wealth Club, said the latest figures create more financial headroom for the Chancellor and reduce the need for substantial cuts to public spending. 

“However, we think there’s a significant risk that inflation kicks off again later in the year. Employers are set to start paying higher rates of National Insurance in April, pushing up labour costs.

“That is likely to see prices rise in sectors like hospitality and retail that employ substantial numbers of people and wear margins are already pretty thin. That risks sparking an inflationary spiral. It could be a tense few months as we wait and see how things play out”

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