Why a small drop in inflation matters to you

A marginal dip in the headline rate of inflation would not normally determine much, if anything.

Inflation rising at 2.5% rather than 2.6% does not change much in big economics, nor in the cost of living squeeze felt by households. The fall is entirely accounted for by falls in hotel prices and a smaller-than-usual rise in airfares in December.

But this unusually important 0.1% drop signals relief, and some respite for Chancellor Rachel Reeves, because of what underpins it.

The underlying inflation numbers, which show where price pressures are going over the year, are what is most keenly watched by the Bank of England in terms of interest rate cuts.

Core inflation, which strips out the direct impact of volatile energy and food prices is now at a four-year low, having dropped to 3.2% in December from 3.5%. Services inflation is at a two-year low of 4.4% after a chunky fall from 5%. This is the real positive news.

For the real nerds, inflation in supply chains, including in services, also indicates muted inflationary pressures.

So the inflationary picture in the UK can be cast in a rather different light. While no-one can predict exactly how the Bank of England will react, it clears away objections to an interest rate cut next month. The markets scrambled this morning to keep up, now back forecasting further rate cuts after February this year.

However, there are two big uncertainties – whether President-elect Trump will bring in tariffs at the scale he has threatened, and how companies in the UK react to the forthcoming increase in National Insurance Contributions (NICs) in April and the rise in the minimum wage. A rise in energy prices which will hit bills is also predicted for April.

Both tariffs and the forthcoming changes to NICs and the minimum wage may not end up being as problematic for the UK economy as some are warning.

While some are expecting firms to raise prices as a result of the Budget changes, some companies may also choose to squeeze wages with lower-than-expected annual wage increases. The overall inflationary impact depends on how firms react and the truth is we don't know yet.

Similarly Trump's tariffs are likely to be inflationary for the US and therefore affect US interest rates. But some at the Bank of England can see a scenario where cheaper tariff imports, for example from China, are diverted to the UK helping to rein in UK inflation.

What actually happens is again uncertain but the outcome may be counterintuitive to what people expect.

So the marginal fall in UK inflation can be seen as something of a firebreak, for now, popping something of the frothy hysteria seen over the past few weeks. Those shorting the UK on international markets will see that there is another side to this bet. UK inflation is in the middle of the G7 pack.

That said, what has been called a global "bond market tantrum" remains in place, sensitive to every new piece of data. The UK government still has to convince on the detail of growth plans. It will mean fast-tracking infrastructure, industrial and trade strategies.

Market borrowing rates remain at levels where the chancellor will probably need to course-correct spending plans with new cuts before Easter, in order to meet her self-imposed borrowing rules.

The shadow cast over inflationary prospects and so all markets by Donald Trump's unconventional trade policies looms large.

The turbulence has not gone away. Inflation is likely to tick up again in the coming months. But right now headline and underlying inflation numbers in the UK all point in the right direction. It is a welcome safe harbour for now, but the seas remain choppy.