UK inflation rose unexpectedly to 4.0% in December in the first increase for 10 months, complicating the timing of interest rate cuts from the Bank of England this year.
Shares on the FTSE 100 slumped 1.5% to register the worst daily fall since last August as investors bet that interest rates would be cut more slowly this year by the Bank of England than previously forecast.
The price of Brent crude dipped more than 2% before a modest recovery to $77 a barrel with oil traders blaming the downturn on figures showing that China, the world’s largest consumer of oil, food and metals, grew more slowly than expected in the fourth quarter of 2023.
Investors have poured funds into company stocks in the expectation of an economic recovery fostered by cuts in the cost of borrowing from the highest levels since the 2008 financial crisis.
Warnings from officials at the European Central Bank that interest rates would need to remain high for much of the year to bring down inflation across the 20-member eurozone were another trigger for the broad-based sell-off in stocks.
The Office for National Statistics said the UK’s annual inflation - as measured by the consumer prices index - went up from the 3.9% reading in November, confounding City economists’ forecasts of a modest decline to 3.8%.
Financial markets pared back expectations for a first cut to come in May, with June now seen as more likely, while also betting on a smaller reduction in borrowing costs by the end of the year from about 1.24 percentage points before the data to about 1.12 percentage points.
The increase in the annual rate was largely the result of increases in the cost of tobacco – after the chancellor, Jeremy Hunt, announced higher duty in the autumn statement – and alcohol.
Tobacco prices increased by 16% on the year while alcohol was up 9.6%, as the cost of buying cigarettes and drink contributed the most to inflation since 2006.
Grant Fitzner, the ONS chief economist, said the tobacco and alcohol rises “were offset partially by falling food inflation, where prices still rose but at a much lower rate than this time last year. Meanwhile, the prices of goods leaving factories are little changed over the last few months, while the costs of raw materials remain lower than a year ago.”
Core inflation, which excludes volatile items including energy, food, alcohol and tobacco, was unexpectedly unchanged at 5.1%, in a development that will be watched closely by the Bank before its next rate decision on 1 February. Services inflation increased slightly from 6.1% to 6.2%.
Motor fuel prices fell by 10.8% in the year to December, compared with a decline of 10.6% in the year to November, after a drop of about 8p a litre for petrol and diesel on the month.
The December figures will be used by some of Britain’s largest mobile phone and broadband operators to increase prices this spring, months before a ban from the telecoms regulator Ofcom on firms imposing inflation-linked rises in the middle of a contract. With most operators adding 3.9 percentage points on top of inflation, consumers face an increase of nearly 8%.
Despite the small increase in the headline rate, inflation has fallen back by more than Threadneedle Street was expecting in November. Economists said it was probably still on track to drop below the Bank’s 2% target by the spring, but warned against expectations for a smooth decline.
Inflation figures for January published next month will take into account the 5% rise in the Ofgem energy price cap in Great Britain, with potential to drive up the headline rate. City economists expect the cap to fall by about 10% in April amid a wider decline in wholesale prices, helping to bring down overall inflation.
However, concerns are mounting over the impact from geopolitical tensions and disruption to shipping in the Red Sea.
Sarah Coles, the head of personal finance at the analysts Hargreaves Lansdown, said: “There are likely to be more knocks on the way, with conflict in the Red Sea raising the risk of supply shortages, which could feed into higher prices. There’s the risk this could end up throwing a real spanner in the works.”
Inflation hitting 4% in December does, however, enable Rishi Sunak to declare victory on his top economic priority for 2023, after he promised last January to halve the rate by the end of the year at a time when it was above 10%. Most economists had expected it to drop by this much anyway, but inflation has proved more persistent than first anticipated.
Eurozone inflation rose to 2.9% in December, while US inflation increased to 3.4%.
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 took difficult decisions to control borrowing and are now turning a corner, so we need to stay the course we have set out, including boosting growth with more competitive tax levels.”
Labour’s shadow chancellor, Rachel Reeves, said: “Prices are still rising in the shops, with the average weekly shop £110 more than it was before the last general election, and the average family set to be £1,200 worse off under Rishi Sunak’s tax plan.”
