December’s unexpected decline in the inflation rate, to 2.5%, is a fillip for the chancellor, Rachel Reeves, opening the way for an interest rate cut next month.

While much of the bond market sell-off in recent days has been driven by global concerns, part of it related to fears that the UK was sliding towards “stagflation” – a nasty combination of slow growth and sticky prices.

December’s consumer price index (CPI) reading of 2.5%, down from 2.6% in November, suggests inflation is moving in the right direction.

That should help to calm the fears of policymakers on the Bank of England’s nine-member monetary policy committee that, with wages growing relatively strongly, inflation could prove difficult to wrestle back to its 2% target.

In particular, core inflation, which strips out the volatile elements of energy, food, alcohol and tobacco, declined to 3.2% in December, down from 3.5% a month earlier.

These domestically generated price increases are the ones the Bank tends to fret about the most.

The cost of a night out or a weekend away in December seems to have been a key part of the picture: the Office for National Statistics singled out hotels and restaurants as a driver of the slide in the CPI.

On an annual basis, inflation in restaurant and hotel prices was 3.4% – down from 4% a month earlier, and the lowest since July 2021, when the economy had not fully reopened after the pandemic.

Downward pressure also came from transport prices, which were down by 0.6% in the year to December, driven by falling air fares – though the cost of secondhand cars increased.

Meanwhile, food prices, which were a significant source of inflationary pressure through 2022 and 2023, were up by 2% in the year to December – unchanged from November.

Retailers have warned that they may increase food prices in the months ahead, as changes announced in Reeves’s budget push up business costs from April.

But for the moment, CPI inflation appears to be heading steadily in the right direction, which should help to alleviate some of the alarm in financial markets. Shortly after Wednesday’s figures were released, markets were putting a 74% probability on an interest rate cut on 6 February.

Calmer markets should also ease the pressure on Reeves – not that she was ever the “lame duck” depicted in some headlines.

The focus will now switch to Thursday’s gross domestic product data for November, which will be a test of the growth part of the stagflation picture.

Meanwhile, inflation is still above the Bank’s 2% target, and City analysts did not dramatically shift their expectations of interest rates in 2025, as a result of the relatively benign CPI reading, with two cuts currently priced in.

Ed Monk, of the investment management firm Fidelity International, suggests the dilemma for Threadneedle Street remains. “Higher rates are restricting economic activity, but the Bank clearly still fears any loosening of borrowing cost could let price rises accelerate, heaping yet more pressure on households,” he said.

However, such is the intensity of the market’s focus on UK data, a significant increase in the CPI could have sparked another jump in bond yields, just as the chancellor hopes to switch the message to how she will generate growth.

Reeves’s response to the inflation data was that there was “still work to be done to help families across the country with the cost of living”. But there will have been a sigh of relief in the Treasury when they got the news.

• Inflation
• Rachel Reeves
• Interest rates
• Bank of England
• Government borrowing
• Gilts
• Economic policy
• analysis