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1. CPI inflation remains above 3%, driven by services and food
2. Increasing labour market spare capacity and a gradual decline in wage growth
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UK inflation measured by the Consumer Price Index (CPI) rebounded in December, reaching 3.4% YoY, after 3.2% YoY in November. This figure is slightly above the consensus forecast of 3.3%, but below the Bank of England's (BoE) projection of 3.5% (which we also shared).
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Core inflation remained unchanged at 3.2% YoY. Services inflation accelerated from 4.4% YoY in November to 4.5% YoY in December, largely due to higher airfares.
A sharp decline in inflation is on the horizon for 2026, with inflation falling below the 2% target as early as Q226. This expected improvement is mainly due to lower energy prices, combined with below-potential economic growth and labour market spare capacity. Our projections point to CPI inflation averaging around 2% for 2026 and 2027.
Although underlying inflation is also trending downwards, it is expected to remain above target for most of our forecast period, supported by wage dynamics that are struggling to normalise completely.
Wage growth declined to 4.5% YoY in September-November, compared with 4.6% YoY in August-October. The memory of recent supply shocks remains fresh in the minds of households, whose inflation expectations remain high. This phenomenon suggests that wage disinflation will continue to stretch out over time.
Contacts / Experts
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CitationInflation appears to have peaked Q325. It is expected to be around 3% Q126 before falling well below the 2% target in Q226, driven by favourable base effects (as the impact of administered price increases Q225 drops out of the twelve-months comparison) and by a series of government measures aimed at reducing household energy bills from April 2026 onwards. For the BoE, the December figures come as no real surprise. At its last monetary policy meeting in December, the central bank had anticipated a temporary rebound in inflation in December, attributable to the increase in tobacco tax and higher airfares.
