Inflation in the UK unexpectedly decreased in December, a development that could increase pressure on the Bank of England to reduce interest rates next month and provide the government with some relief after recent financial market turbulence, reports AP.

The Office for National Statistics reported on Wednesday that inflation, as measured by the consumer price index, stood at 2.5% in the year to December, primarily due to easing price pressures in the services sector, which constitutes around 80% of the UK economy.

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This was down from 2.6% the previous month, with economists having predicted no change in the annual rate.

While inflation has decreased, it remains above the Bank of England’s target of 2%. The bank determines interest rates based on its inflation expectations for the next one to two years. Therefore, if policymakers overlook a projected rise in inflation in the coming months, they may decide to cut borrowing rates at the next policy meeting on February 6, potentially providing relief to Treasury chief Rachel Reeves, who has faced negative headlines recently over her handling of the economy since Labour returned to power last July after 14 years.

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“The small decline in inflation will bring significant relief to both the Treasury and the Bank of England,” said Luke Bartholomew, deputy chief economist at abrdn.

At the beginning of the year, financial markets anticipated three to four quarter-point interest rate cuts this year from the current 4.75%. However, in recent weeks, concerns about the UK’s inflation outlook have reduced those expectations.

This shift has been reflected in the bond market, where the interest rate investors charge the UK government for 10-year loans has reached a 16-year high, partly due to concerns over the economic policies of U.S. President-elect Donald Trump and domestic issues.

Regardless of the cause, these bond market shifts are likely to lead to higher interest payments for the government, adding pressure to Reeves' public finance projections.

Critics argue that her first budget, delivered last October, will result in higher inflation than otherwise expected. The increased public spending in the budget will largely be financed through higher business taxes and borrowing. Some economists believe this spending spree, coupled with businesses potentially raising prices to offset tax hikes, could push inflation upwards and lead to higher interest rates.

Inflation has significantly dropped from levels seen a couple of years ago, partly due to central banks raising borrowing costs from near-zero during the pandemic when prices began to rise due to supply chain disruptions and, later, Russia's full-scale invasion of Ukraine, which caused energy prices to surge.

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As inflation has decreased from multi-decade highs, central banks have begun reducing interest rates, though few economists expect rates to return to the super-low levels seen in the years following the global financial crisis of 2008-2009.