Inflation has increased unexpectedly for the first time in nearly a year after alcohol and tobacco price hikes, dampening hopes of an early interest rate cut by the Bank of England.
Figures from the Office for National Statistics (ONS) showed the rate of Consumer Prices Index (CPI) inflation rose to 4% in December, up from 3.9% in November – marking the first increase since February last year.
The shock rise was largely driven by last November’s tax hike on tobacco, as well as higher alcohol prices and air fares.
Most economists had expected inflation to edge lower to 3.8%.
The FTSE 100 Index fell 1.7% to 7,427.4 as financial markets trimmed their rate cut expectations while the pound jumped on expectations that rates will now stay at 5.25% for longer.
Sterling lifted 0.4% to 1.27 US dollars and was also 0.4% higher at 1.17 euros.
Economists said it was still likely the Bank will look to trim rates this year.
They cautioned that the path of inflation may not be smooth, with another possible increase in January and concerns over the impact of the Red Sea shipping attacks on prices, but are forecasting CPI to drop sharply over the coming months.
The increase in CPI came just hours after Rishi Sunak said the Government had met its pledge to halve inflation and claimed “it has continued to fall”.
Chancellor Jeremy Hunt insisted that the Government’s “plan is working”.
He said: “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.”
He said the inflation risk posed by the Red Sea crisis was one of the reasons for the UK-US military strikes against Houthi targets, as fears grow that it could push up the cost of oil, gas and goods.
Mr Hunt told broadcasters: “It’s precisely because we are concerned about what’s happening in the Red Sea that the UK has taken action with the United States and our other allies to secure freedom of navigation. We are obviously watching the situation very carefully.”
The surprise rise in UK inflation comes after alcohol and tobacco inflation hit a high of more than 31 years last month, at 12.8%.
Tobacco prices surged by 16% year on year in December while alcohol inflation hit 9.6% as prices continued to rise after a duty rise on booze in August last year.
Air fares also rose as usual between November and December, up by 57.1%, compared with a 61.1% rise a year ago.