Prices in the UK rose by 3% in the 12 months to January 2025, marking a higher-than-expected increase from December. This pushes inflation further away from the Bank of England’s target. The Bank adjusts interest rates to maintain a 2% inflation target and has made three cuts since August 2024. However, it warned of a potential rise in inflation again in 2025.
What Is Inflation?
Inflation refers to the rate at which prices increase over time. For example, if a bottle of milk costs £1 and rises to £1.05 the next year, the annual milk inflation is 5%.
How Is the UK Inflation Rate Measured?
The Office for National Statistics (ONS) tracks price changes of hundreds of everyday goods, including food and fuel. These are compiled into a “basket of goods,” updated to reflect shopping trends. In 2024, vinyl records and air fryers were added, while hand sanitiser was removed.
The ONS calculates inflation using the Consumer Prices Index (CPI). In January 2025, CPI inflation was 3%, up from 2.5% in December 2024. This increase is mainly due to rising food prices, VAT on private school fees, and smaller-than-expected drops in airfare costs.
Why Are Prices Still Rising?
Inflation peaked at 11.1% in October 2022, the highest in 40 years. While inflation has since decreased, it means prices are rising at a slower rate rather than falling.
Inflation surged in 2022 due to high demand for oil and gas post-pandemic, followed by energy price spikes after Russia’s invasion of Ukraine. Food prices also contributed to the prolonged inflationary pressure.
How Do Interest Rates Affect Inflation?
To combat high inflation, the Bank of England raised interest rates to 5.25%, the highest in 16 years. Raising interest rates makes borrowing more expensive, reducing consumer spending and slowing price increases. However, higher rates also impact mortgage repayments and business investments, which can affect economic growth.
What Is Happening to UK Interest Rates?
The Bank of England cut interest rates three times:
- August 2024: From 5.25% to 5%
- November 2024: From 5% to 4.75%
- February 2025: From 4.75% to 4.5%
The Bank also considers “core inflation,” which excludes volatile food and energy prices. In January 2025, core inflation was 3.7%, up from 3.2% in December 2024.
After the October 2024 Budget, the Bank projected that policies such as an increase in National Insurance Contributions would slightly raise inflation. In February, Governor Andrew Bailey emphasized a cautious approach to future rate cuts due to economic uncertainties.
Inflation is expected to peak at 3.7% between July and September 2025 due to higher energy costs, increased water bills, and rising bus fares. The Bank anticipates inflation will return to the 2% target by late 2027.
The next interest rate announcement is scheduled for 20 March 2025.
Are Wages Keeping Up with Inflation?
The latest data shows that wages grew faster than inflation between October and December 2024. Regular pay (excluding bonuses) increased by 5.9%, compared to 5.6% in the previous period. Adjusted for CPI inflation, real wages rose by 3.4%, the highest growth in over three years. Private sector earnings outpaced public sector pay.
How Do Inflation and Interest Rates Compare in Europe and the US?
The US and European economies are also managing inflation:
- Eurozone Inflation: 2.5% in January 2025 (up from 2.4% in December 2024). The European Central Bank (ECB) cut its interest rate from 4% to 2.75% through four consecutive cuts since June 2024.
- US Inflation: 3% in January 2025 (up from 2.9% in December 2024). The Federal Reserve cut rates three times in late 2024, bringing them to 4.25%-4.5%. The Fed held rates in January 2025, signaling no immediate changes.
Related Topics
- How the UK Budget Affects Inflation
- Impact of Inflation on Mortgage Rates
- What Rising Prices Mean for Consumers
- Global Inflation Trends in 2025