The UK’s headline inflation rate has climbed back to 3%, up from 2.5%, after briefly dipping below the Bank of England’s (BoE) 2% target last autumn. This rise is slightly higher than expected, largely due to a near-1% month-on-month increase in food prices—a jump that remains somewhat unexplained. However, we anticipate inflation to hover around the 3% mark for much of 2025, with a peak of 3.5% expected later this year.

One of the key drivers of this trend is household energy bills, which are set to rise again in April, thanks to higher wholesale natural gas prices.

What Matters More: Services Inflation

Despite the focus on headline inflation, the Bank of England is more concerned with services inflation when making policy decisions. The latest data shows that services CPI rebounded to 5%, though this was lower than expected and partly influenced by an unusually low reading in December. The key distortion? Airfares, which didn’t fully capture the typical price surge around Christmas.

However, airfares—and other volatile items like package holidays and rents—don’t carry much weight in the BoE’s decision-making process. Instead, what matters is ‘core services’ inflation, which strips out these fluctuations.

By our calculations, core services inflation now sits at 4.2%, down from 4.7% two months ago. This downward trend is expected to continue, potentially dipping below 4% in the next couple of months. Meanwhile, overall services inflation could reach that level by summer, which would be a faster decline than the BoE is currently forecasting.

What This Means for Interest Rates

The good news is that the gradual decline in core services inflation suggests that inflationary pressures are easing. This supports our view that the BoE will cut rates four times this year, bringing the Bank Rate down steadily.

Looking further ahead, we expect rates to fall to 3.25% in 2026, which is lower than what markets are currently pricing in. While this doesn’t necessarily mean rate cuts will come sooner than expected, it does reinforce the idea that the BoE’s tightening cycle is over and the focus is now shifting toward easing monetary policy.

Final Thoughts

Inflation may have ticked up, but the bigger picture suggests it is still on a downward path—especially in the key areas that matter most for the Bank of England’s decision-making. As a result, while inflation headlines might seem concerning, the trend points toward a gradual return to lower interest rates over the next couple of years.