The surprise uptick in inflation could potentially halt mortgage rate cuts in the near-term, but analysts still expect interest rates to be cut this year.

The Consumer Prices Index (CPI) increased to 4% in December, from 3.9% a month earlier, fuelled in part by increases in tobacco and alcohol prices.

The rise in CPI has complicated expectations for a Bank of England base rate cut in the first few months of this year, after most economists had expected inflation to fall to 3.8%.

Traders have dialled down their bets on a base rate cut by the Bank of England in May. Before yesterday’s inflation figure, the market had expected there to be an 80% chance of the rate being cut, but this dropped to 60% on Wednesday morning.

“A surprise jump in inflation is not good news,” Nicholas Hyett, Investment Analyst, Wealth Club, said. “Policy makers, mortgage holders, investors and the average shopper had all been hoping price rises continued to slow over Christmas  – clearing the way for lower interest rates and easing the cost of living crisis.”

But with energy bills predicted to fall this year, there are expectations of rate cuts later this year.

Andrew Gething, managing director of MorganAsh, commented: “The inflation figures are a reminder that firms shouldn’t count their chickens just yet. While there has been much expectation of reaching the 2% target and a potential base-rate drop, the first increase in inflation in almost a year shows we may still be some way off. Markets and economists have been very confident about future cuts, despite ongoing caution from the central bank.

“Positive news on wholesale gas prices, as well as easing food and petrol prices are no doubt encouraging, although a December rise has been driven by pressure on key consumables such as alcohol and tobacco.”

The Bank’s rate currently stands at 5.25%, a 15-year high, which has led to higher mortgage rates due to the cost of borrowing money being more expensive. Returns on savings, however, have also gone up.

But financial markets and traders are now expecting it to cut its base rate in 2024 due to the inflation rate falling sharply since peaking at 11.1% in October 2022, which was the highest rate in 40 years.

Inflation has also fallen quicker than the Bank had predicted, but it still remains nearly double its 2% target.

The Bank’s Monetary Policy Committee (MPC) is widely expected to cut the base rate by somewhere between 1% and 1.25% during the year – from its current level of 5.25%.

Nicholas Mendes, of John Charcol, said: “Despite the slight uptick in the latest figures the big picture is that inflation is falling more sharply overall than what the Bank of England and financial markets expected a few months ago.”

Andrew Montlake, of Coreco mortgage brokers, added: “Today’s inflation figures are a stark reminder that nothing can be taken for granted, though the small rise should be viewed as a metaphorical speed bump rather than a fundamental change of direction.

“It could mean a slight pause to the New Year rate wars we have seen, but competition between lenders is unlikely to wane too much. It is a timely reminder that it is a fool’s folly to try to play the market, and locking into a rate early is a safer play for many.”

Major forecasters have also stuck to their guns on their predictions for when cuts to the base rate will occur, with the first likely to be made in May or June.

Nathan Emerson, CEO of Propertymark, said: “It’s imperative to remain mindful the coming months will feel like a transition period as we find a healthier balance again. Last year the Governor of the Bank of England hinted there would be no quick drops in interest rates in order to keep check on inflation.

“For homeowners it will mean a higher level of vigilance regarding household budgeting will need to remain for a while yet. For buyers and sellers, it will likely mean very careful planning on searching out the best options for your personal circumstances.

“There is positive news within the property market however, we are starting to the house prices in many areas springing back to growth again and Propertymark are optimistic this will become a more widespread picture as we head further into 2024.”

Rightmove’s Tim Bannister added: “This morning shows that we can still expect some economic surprises this year, and agents report that the market is still very price sensitive. However, we’re seeing much more confidence from many movers at the start of this year, who are determined to get on with their plans.”