Inflation unexpectedly fell to 2.5% after two months of rising, according to official figures.
This means prices are still rising, but at a slower rate than before, according to December data from the Office for National Statistics (ONS).
Economists expected this figure to remain at 2.6%, the level recorded in November.
Inflation is still above the 2% target set by interest rate makers. Bank of England but exactly as they had planned in November.
What does this mean for interest rates?
This means there will be a greater chance of an interest rate cut when the Bank’s Monetary Policy Committee meets in three weeks.
Before the inflation announcement, markets believed there was a 62% chance of a decline, but after the release this probability increased to 74%.
Beyond the headline Consumer Price Index (CPI), there are other figures that will be good news for the Bank and for Chancellor Rachel Reeves, who faces growing pressure over her management of the ‘economy.
Two indicators closely watched by the Bank fell more than expected.
Services inflation, which remains high and is impacted by salary increasefell from 5% a month earlier to 4.4%, well below the 4.9% predicted by economists.
Likewise, core inflation – which tracks rising prices excluding energy and food, which can be volatile – fell to 3.2% from 3.5% in November.
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Why has the inflation rate fallen?
Inflation was slowed by restaurants and hotels raising their prices less than before. Tobacco prices also increased less than the same month a year earlier.
The rising cost of fuel and used cars has helped drive up inflation.
Responding to the data, Ms Reeves said: “There is still work to be done to help families across the country cope with the cost of living. This is why the government has taken measures to protect workers’ pay slips against tax increases, frozen fuel taxes and increased the national minimum wage.