In October 2023, Bank of England governor Andrew Bailey said: “There is a saying in the central bank world that the last mile is going to be the hardest one.”

Bailey was of course referring to the UK’s ongoing battle with inflation. But earlier this week it appeared the Bank had reached the home straight in its race to drive price rises below 2% with fresh legs.

Data revealed yesterday, however, suggests reaching the finish line might be tougher than previously thought.

The UK’s main measure of inflation, consumer prices index (CPI), unexpectedly rose from 3.9% to 4% in December, after easing significantly in the three months prior. The consensus was that price rises would continue to temper last month - albeit at a much slower pace.

Such a marginal increase may only prove a fleeting setback; and we can never read too much into a single month’s data. But inflation’s first upswing in 10 months has dampened the economic mood, particularly as it may delay the arrival of interest rate cuts.

It also raises some key questions for investors and borrowers. Here, I answer six of them to provide some clarity about what the recent inflation data might mean for your money.

1. Why has inflation nudged back up?

December’s surprise inflation rise was largely attributed to higher tobacco prices, which increased by 12.9% year on year last month. That followed Chancellor Jeremy Hunt's decision to hike tobacco duty at his Autumn Statement.

These rises were slightly offset by food and drink inflation which fell significantly to 8%. It’s important to note that this doesn’t mean our shopping bills are getting cheaper, they’re simply rising at a slower pace.

Meanwhile, core inflation, which strips out energy and food, remained steady at 5.1%.

2. What’s the forecast for inflation in 2024?

In response to yesterday’s figures, Hunt remained staunch that the government’s plan to bring down inflation is still working. “As we have seen in the US, France and Germany, inflation does not fall in a straight line, but our plan is working and we should stick to it,” Hunt said.

Some economists believe that while inflation may continue to prove stubborn in the short term, the sharp falls we saw in October and November could be set to resume in February.

Before yesterday’s announcement, Capital Economics, the independent research firm, said: “Though the next two CPI inflation releases may fuel the narrative that the downward trend in inflation is stalling, we think that inflation in the UK will fall below the 2% target in April.”

Other economists shared a similar view, predicting that inflation will fall below 2% by May. But these forecasts might be scaled back in response to yesterday’s data.

The Bank is less optimistic, predicting that inflation will exceed 3% throughout 2024.

3. How might this affect rate cuts?

Yesterday’s inflation number has dented the prospect of imminent rate cuts. The market now expects four 0.25 percentage point cuts instead of five in 2024, with the first one arriving later than previously expected.

The Bank, however, still doesn’t expect to wield the axe to interest rates until the second half of the year.

Its Monetary Policy Committee (MPC) - the rate setters - will meet for the first time this year on Thursday 1 February. The Bank will also publish a fresh update to its inflation forecast for 2024.

While it seems inevitable that rates will be kept on hold at 5.25% for the fourth consecutive time, the vote split might be something to watch out for.

At December’s meeting, although six members of the MPC voted to maintain rates, three preferred a 0.25 percentage point increase. And this was despite inflation plunging below 5% in November.

Either way, February’s meeting will offer clearer insight into the Bank’s thinking around interest rates. And it will be interesting to learn whether December’s surprise inflation uptick will prompt a change of tack.

4. What else will influence future interest rate decisions?

Inflation is one of several factors that the Bank considers when setting interest rates - wage rises and economic data are also taken into account. Both metrics have softened recently, which may play into the Bank's thinking when it makes decisions about interest rates.

Average wage increases eased from 7.3% to 6.6% in the three months to November, according to Office for National Statistics (ONS) data and are expected to continue to slow during 2024.

Elsewhere, the UK economy rebounded in November, as gross domestic product (GDP) ticked up 0.3% due to a bumper month for the services sector. This development doesn’t mean the UK will swerve a “technical” recession this year, but it decreases the likelihood.

5. How might this impact my investment portfolio?

Short-term noise is always tricky to drown out, especially when the volume is cranked up.

Investing, however, is a long-term game. So while you should never ignore current headwinds, it’s the bigger picture that matters most.

The UK’s main stock market, the FTSE 100, dropped as much as 2% yesterday in response to the surprise inflation data – the third consecutive day of slides in what’s been a challenging start to the year.

Meanwhile, the pound strengthened and government bond yields rose.

But the outlook for UK stocks looks more buoyant. As Graeme Evans noted in this article for interactive investor, Swiss Bank UBS predicts the FTSE 100 will reach 8,160 points by the end of 2024, while almost half of respondents to interactive investor’s recent survey reckon it will be between 7,500 and 8,000 points.

Regardless of what happens in the short term - and no matter whether your goal is to grow your wealth or draw an income from it - knee-jerk reactions are typically best avoided. The path to lower inflation was always going to be rocky and these occasional bumps may temporarily jar stock markets.

Provided you’re confident in your long-term investment strategy, often the wisest thing to do is simply keep the faith and plough on as normal.

That said, if you rely on drawdown to meet the bulk of your retirement needs, it can be prudent to revisit which assets you choose to draw income from. This can avert selling assets at subdued prices, which may hamper long-term portfolio performance. If markets were to take a nasty turn, a sufficient cash buffer could provide a handy stopgap until things recover.

What yesterday’s inflation data continues to illustrate is the importance of being diversified. Spreading your portfolio far and wide means that the performance of a single market, such as the FTSE, will only impact a proportion of your portfolio, with other markets acting as a counterweight should some regions struggle.

In terms of your cash holdings, the top-paying savings accounts are still outpacing inflation, despite yesterday’s rise, but we don’t know for how long.

Savings rates have reduced over the past few months; the Premium Bond prize fund rate was recently cut from 4.65% to 4.40%, giving holders less chance of winning.

6. What’s the potential impact on mortgage rates?

With rate cuts now expected to be pushed back, this will have some impact on the mortgage market. When interest rates fall, mortgage rates should follow suit.

Borrowers on variable rates may be the most affected, as they may have to wait a bit longer before seeing a reduction to their monthly repayments. The impact could also be felt by anyone with a previously cheaper fixed-rate deal soon to expire.

However, mortgage rates have fallen recently with the rate-hiking cycle grinding to a halt. And it’s worth noting that three major lenders – Coventry, Santander, and Skipton - pushed on with rate cuts yesterday despite inflation creeping back up, as competition in the space cranks up.

According to Moneyfacts data, average rates for two- and-five-year fixed rate deals fell for a fifth consecutive month in January, dropping to 5.93% and 5.55%, respectively. The average two-year fixed rate mortgage hit 6.66% in July 2023.

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