What’s happening with UK Inflation?

Introduction

UK inflation unexpectedly rose to 3% in January 2025, exceeding economist’s expectations of 2.8%. Inflation has been falling steadily since its peak of 11.1% in October 2022 but remains stubbornly above the Bank of England’s (BOE) target of 2%. Despite this the BOE has still cut rates from 5.25% to 4.5% over the last 2 years. However, January’s inflation miss increases speculation of interest rate now cuts cooling off. In this article we look at what’s driving this inflationary surprise, and what does it mean for households and businesses?

Why Inflation Missed Expectations

Several key factors contributed to inflation remaining higher than expected, despite broader economic trends pointing toward a slowdown in price growth.

1. Rising Transport and Travel Costs

Airfares saw a notable increase in January, driven by higher fuel costs, seasonal demand, and supply constraints. Airlines passed these costs onto consumers, leading to sharp price hikes in flight tickets. Travel costs, particularly international fares, were among the biggest drivers of inflation’s unexpected rise.

2. Food Prices Stay Elevated

Despite some relief in global supply chains, UK food prices continue to rise. Essentials like meat, bread, and cereals saw price hikes, reflecting higher production costs, raw material expenses, and transportation fees. While overall food inflation has eased from last year’s peaks, it remains a stubborn contributor to household cost pressures.

3. Education Costs Soar Due to VAT Changes

One of the biggest inflationary shocks came from private school fees, which surged 12.7% in a single month after the UK government removed VAT exemptions. This sudden policy change added significant costs for affected households and pushed overall inflation higher. Since education costs are a component of the Consumer Price Index (CPI), this policy-driven increase played a crucial role in inflation overshooting expectations.

What This Means for Interest Rates

The Bank of England had been under pressure to cut interest rates in 2024, with markets previously expecting reductions as early as the summer. However, with inflation proving more resilient than forecasted, those expectations have now weakened.

Higher-than-expected inflation suggests the Bank may take a "wait and see" approach, ensuring inflation trends downward before making any policy adjustments. If inflation remains sticky over the next few months, interest rates may stay higher for longer, affecting borrowing costs for mortgages, personal loans, and business financing.

For homeowners hoping for cheaper mortgage rates, this means potential delays in affordability improvements. Businesses facing high borrowing costs may also struggle with investment decisions as they await clearer signals from the Bank of England.

The Bigger Picture: Is Inflation Coming Down or Sticking Around?

While inflation is significantly lower than its peak in 2022, its persistence in key areas raises concerns about how easily it will return to the Bank of England’s 2% target. Policymakers will now be closely watching whether January’s inflation surprise is a one-off event or an early signal of inflation’s resistance to further declines. The BOE previously forecast inflation reaching nearly 4% this summer due to elevated energy costs before January’s negative surprise and therefore could be very cautious with rate cuts.

For now, any hope of rapid interest rate cuts has likely faded, meaning businesses, borrowers, and consumers should prepare for a longer period of elevated borrowing costs. Inflation is still trending downward in the long term, but unexpected spikes like this highlight how unpredictable the path to price stability can be.

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