UK inflation rose to 3.4% in December, up from 3.2% in November, but below the Monetary Policy Committee’s (MPC) forecast of 3.5%. The rebound was no real surprise because tobacco duty rises were announced in the Autumn Budget. Looking ahead, inflation should drop to 3% when January’s figures are released next month. It’s likely to stay around that level until April, when it’ll then slow sharply to a little over 2%. That’s because last year’s regulated price increases drop out of the annual comparison. Despite this slowdown in headline inflation over the coming months, we expect the MPC to remain cautious, likely cutting interest rates just once in 2026.

Tobacco duty pushes up UK inflation in December

The big driver of December’s inflation rise was higher tobacco duty, which took effect a month later in 2025 than in 2024 because of the late-November Budget. This factor pushed tobacco inflation in the year-on-year comparison to 6.5% from 4.2%.

What’s more, airfares inflation surged to 11% from 0.3% in December, adding 5bps to the headline inflation rate. While airfares are volatile, this time much of the rise reflects a change in the collection date rather than a genuine surge in price pressures, meaning this factor will unwind in January. However, it helped to drive services inflation up to 4.5% from 4.4% year on year.

Food inflation also rose to 4.5% from 4.2% on the same measure. This might concern the MPC because food prices are the most visible element of inflation in households’ day to day experience and therefore expectations for wage increases. However, we suspect this rise in food inflation is largely payback from a weak November and that food inflation will fall back quickly across 2026, easing the pressure on households.

In the near-term, inflation will ease in January. More favourable base effects will help to drag food inflation down. Education inflation will also ease back a little after last year’s introduction of VAT on private school fees drops out of the annual comparison.

UK inflation to slow sharply, but MPC will be cautious

Further ahead, we expect inflation to fall more significantly in April’s data, taking it to just over 2%. This is when last year’s smorgasbord of regulated price- and tax hikes drop out of the annual comparison. Measures to cut household energy bills and freeze rail fares will also cut inflation by 0.4ppts.

Despite this impending drop in headline inflation, there are a number of reasons why we expect the MPC to be cautious this year. Underlying inflation will be stickier. We estimate the MPC’s own measure of underlying services inflation, which strips out volatile and regulated components, has largely stabilised at around 4% now. Almost all the survey data also suggests disinflation is slowing.

Inflation will likely start rising again later this year. The government will introduce a new vape tax in October and from September gradually start to reverse the temporary 5p cut to fuel duty. While the MPC will want to look through regulated price hikes, it may be tempted to weigh on inflation for a little longer to boost credibility after half a decade of above-target inflation.

Adding to this is that, at 3.75%, interest rates are close to our estimate of neutral. This is the level where interest rates are neither stimulating nor restricting activity. It means the MPC will want to cut more slowly to avoid re-igniting inflationary pressures.

What’s more, geopolitics remains a major risk to the inflation outlook. The price of oil has risen sharply so far this year due to events in the Middle East. The prospect of the UK and Europe imposing their own tariffs on the US should US tariffs over Greenland go ahead would also risk goods inflation going significantly higher than we currently expect.

All told, inflation will slow sharply across the first half of this year. This should give the MPC room to cut interest rates again in April when they’ll be more confident that inflation is returning to 2% and stubborn pay growth has slowed a little more. However, the inflation outlook beyond the first half of the year is less certain, so we expect just one cut this year while the MPC assesses future price pressures.

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