UK inflation fell from 3.4% in December to 3% in January, the lowest annual inflation rate since March 2025, boosting hopes of a cut to interest rates by the Bank of England next month.
Core CPI (CPI excluding energy, food, alcohol and tobacco) rose by 3.1% in the 12 months to January, down from 3.2% in December - its lowest level since September 2021.
In addition, yesterday's labour market data showed headcount reductions, rising unemployment and easing vacancies. Unemployment is now at its highest level since January 2021 and the number of salaried workers fell by 11,000 last month, down by 134,000 compared to the same time last year. Wage inflation is also cooling and private sector wage growth has dipped to its lowest level in five years.
The data shows clearer signs of a weakening labour market feeding through to slower pay growth, "which will give the Bank of England more confidence in cutting interest rates over the course of this year", Adam Hoyes, senior asset allocation analyst at Rathbones said.
He added: “The softening labour market has been a key concern for the more dovish members of the Bank of England’s Monetary Policy Committee for a while, but what may be more important for the convincing some of their more hawkish colleagues to join them in backing interest rate cuts is the latest slowdown in pay growth."
George Lagarias, chief economist at Forvis Mazars, agreed: “Gravity is finally settling in. An economy of sluggish growth, climbing unemployment and softer wage growth, in the eye of a global trade disruption, has absolutely zero reason to be consistently inflationary. The Bank of England still waited for proof and now it has it. We would expect to see faster rate cuts going forward from this point on.”
David Hollingworth, associate director at L&C Mortgages, commented: “The rate of inflation was widely expected to take a sharp fall in January, after the larger than anticipated rise in December. This will further the hope that inflation is now on the downward path, to take it closer to the Bank of England’s target.
“It will do nothing to derail the chance of another base rate cut to come as soon as next month, especially after the rate of unemployment rose again yesterday. The tight 5-4 vote to hold base rate this month, with the minority preferring a cut, has also strengthened the market’s belief that base rate will be cut further.
“That should bring good news for mortgage borrowers. With another two cuts to base rate now looking more likely, there should be favourable market movement to help mortgage lenders improve their rates.
“Fixed rates had been edging higher in recent weeks, but we’ve seen those rises steady and some lenders cutting rates back, as sentiment around the rate outlook has improved. Today’s news should help firm that up and if lender funding costs continue to ease, we could see more cuts to unwind some of the recent hikes.”
Jonathan Moyes, head of investment research at Wealth Club, added: "We are going to be hearing a lot about base effects this year. Big inflationary spikes from energy, employers’ national insurance, and the private school fee VAT hike from earlier in 2025 that should roll out of the 12-month window for inflation as we move through 2026. This will have a cooling effect on inflation, and we should see inflation fall back to 2% this year.
"On the back of weak employment and wage growth data from yesterday, there would have been many revising their expectations for inflation overnight. Instead, inflation came in bang in line with expectations. The market reaction is expected to be muted as a result.
"What does all this mean for the Bank of England? The next meeting is on 19th March. With a deteriorating labour market, weak wages, weak economic growth, and no ugly surprises on inflation, it is likely we will see our first rate cut of 2026. The economy may need several more before it begins to show signs of life. For an embattled government starved of good news, they couldn’t come soon enough.”
