January Sees 10-Month High in Inflation, Impacting Wages and Government Fiscal Plans Amid Rising Food and Education Costs

Inflation in the UK rose sharply at the beginning of 2025, surpassing expectations and diminishing the likelihood of an interest rate cut in the near future.

According to the Office for National Statistics (ONS), the Consumer Prices Index (CPI) climbed to 3% in January, up from 2.5% in December. Analysts had forecast a smaller increase to 2.8%.

The rise was driven by higher costs for food staples such as meat, bread, and cereals, alongside a surge in private school fees following the government’s decision to remove VAT exemptions for independent education.

Air travel prices fell in January but not as significantly as in previous years, and fuel prices increased, pushing transport sector inflation to its highest point since early 2023.

Dean Butler of Phoenix Group noted that the increase in inflation has disrupted expectations of a steady decline in interest rates this year, making the Bank of England less inclined to implement aggressive rate cuts.

Financial markets responded by reducing the probability of a rate cut in March to 15%, down from 24% prior to the inflation report. Despite this, investors still anticipate two further rate reductions in 2025, following the Bank of England’s recent decision to lower rates to 4.5%.

Chancellor Rachel Reeves emphasised her commitment to improving household incomes, highlighting recent real wage growth. However, she acknowledged that many families continue to struggle with rising costs. There are concerns within the government that persistent inflation could lead to increased wage demands from public sector workers, exceeding the 2.8% pay rise currently budgeted.

A slower reduction in interest rates could also place additional strain on public finances by increasing borrowing costs beyond initial forecasts by the Office for Budget Responsibility (OBR). The OBR is set to provide an updated economic outlook in its upcoming fiscal report.

Economic analysts predict inflation may climb further to 3.7% this year due to rising energy costs and utility price increases. While January’s spike in inflation presents a setback for ministers, some experts believe this surge is temporary and anticipate a downward trend in the months ahead.