Inflation drops to 3% as rate cut hopes rise

The UK inflation rate fell to 3% in the year to January 2026, according to the latest data from the Office for National Statistics (ONS), down from 3.4% in December 2025 and marking the lowest rate in ten months.

That said, although the rate of inflation has fallen significantly from December, it still remains above the Bank of England’s 2% target.

A fall was largely expected by economists, however the drop from December’s 3.4% rate was a little more than expected. As a result of this, the number of expected interest rate cuts this year has increased to more than the two expected, causing the stock markets to begin pricing in the change.

 Generally falling inflation figures are good news for the economy. A falling inflation rate paves the way for increased interest rate cuts, which in turn should be good news for rising equity markets, lower mortgages, and higher employment rates. And with unemployment at 5.2%, the highest level in nearly five years, interest rate cuts will hopefully be welcome to many searching for jobs. 

Why is inflation falling? 

According to ONS figures, meat, motor fuels and airfares all played a pivotal role in bringing down inflation since December, partially offset by the cost of hotel stays and takeaways, which rose.  

Another significant influence on inflation falling over the last 12 months, is that the VAT increase to school fees last year, has now dropped out of the figures. 

Food inflation fell from 4.5% to 3.6%, an encouraging change considering how sticky food prices have been in the past few years, and the lowest in nine months.

Easing transport costs were an additional contributor, with air fares reversing December’s spike and petrol prices dropping by 3.1p per litre between December 2025 and January 2026. According to ING THINK, the research and analysis division of ING Bank, inflation is expected to continue to fall this year, and actually get down to the 2% target by the summer, although the April figures will be the big test, as important measures such as energy costs are repriced in that month.

As a result, it’s expected that the next base rate cut will occur next month at the Bank of England meeting on 19th March 2026, with another in June.

What is inflation and how is it measured?

Inflation is a measure of how the prices of goods and services have increased over time. Goods are tangible items sold to customers, such as food, while services are tasks performed for the benefit of recipients, such as a haircut. Generally, this increase is measured by considering the cost of things today compared to how much they cost a year ago. The average increase between these prices is demonstrated in the inflation rate.  

Rising interest rates directly affects the cost of living. For example, if the price of a bottle of milk is £1, and inflation is increasing by 5%, then your bottle of milk will cost you 5p more. Or, in other words, the spending power of your money has decreased by 5%.  

Ideally, the Government wants to keep inflation low and stable. The general mandated target for the Bank of England is 2%. Anything significantly above or below this target is thought to cause issues for the economy.  

The cost of living surged in recent years, with inflation peaking at 11% in 2022 - way above the Bank of England's 2% target, partly due to the increase in energy prices following Russia's invasion of Ukraine.

While the rate has dropped, falling inflation does not mean the goods and services are coming down in price overall, it is just that they are rising at a slower pace.

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This article is for information only and does not constitute individual advice.