UK Inflation Hits 3.4%: BoE Faces 'Last Mile' Disinflation Hurdles

UK CPI inflation rose to 3.4% year-on-year in December 2025, edging higher from 3.2% in November and exceeding market expectations of 3.3%. While core inflation remained steady at 3.2%, the immediate takeaway for traders is that the disinflationary process is rarely linear, significantly complicating the Bank of England's (BoE) timeline for monetary easing.

Deciphering the December CPI Data

The modest upside in headline CPI does not necessarily signal a reversal of the long-term trend, but it does tighten the communication constraints for BoE policymakers. December’s rise was largely attributed to seasonal swings and tax-related items. This creates two simultaneous market realities: a headline figure that appears stubborn and an underlying trend that may still align with the 2% target later in 2026.

The core policy complication is that the BoE’s mandate extends beyond current inflation prints. The committee is hyper-focused on whether premature easing could re-ignite domestically generated inflation, particularly within the services sector and wage growth.

The 'Last Mile' Problem and Services Stickiness

Late-stage disinflation is notoriously messy. While goods prices often drive the initial descent in inflation, the 'last mile' depends on three critical factors:

• Services Pricing Behavior: This remains the primary constraint for the BoE.
• Wage Dynamics: Labour market slack is required to cool second-round effects.
• Inflation Expectations: Anchoring these expectations is vital to prevent a wage-price spiral.

A one-tenth surprise in the CPI data is not a dealbreaker, but it necessitates a more cautious framing for the first half of 2026. If services inflation does not show a clear cooling trend, the BoE is likely to maintain a restrictive stance for longer than the market initially priced in.

Implications for the BoE Rate-Cut Path

The December print increased the probability that the Bank of England will adopt a "wait for confirmation" approach. The central question for the Gilt market is whether current policy is restrictive enough to keep downward pressure on services without triggering a recession.

A plausible base case for the pound sterling (GBP) is a gradual easing cycle, conditional on upcoming data. Any re-acceleration in wage growth would likely push the first rate cut further into the late summer or autumn of 2026.

Market Read-Through

• Gilts: Front-end rates remain the most sensitive. Anticipate a lift in short-end yields as easing expectations are pushed back.
• Sterling: GBP may find marginal support from a less dovish BoE, provided global risk sentiment remains stable.
• Risk Assets: Volatility may increase as the market adjusts to a "stop-start" easing profile rather than a smooth descent in rates.

What to Watch Next

Investors should look beyond the headline CPI for the following confirmation signals:

1. The trend in services inflation.
2. Upcoming wage prints and unemployment indicators.
3. Shifts in inflation expectations surveys.
4. Real-economy activity data to gauge growth risks.

For a broader view of how policy uncertainty is impacting global markets, see our analysis on FTSE 100 Policy Risk or the Europe Inflation Outlook.