The ONS published January's CPI data and the latest labour market figures this week. The headline inflation rate fell sharply but it’s still high at 3.0%. Look underneath and it’s government policy holding it up.
The Key Number
Services CPI: 4.4%
CPI fell to 3.0% in January – down from 3.4% in December – the biggest monthly drop in a year. But services inflation, which covers around 80% of the UK economy, dropped just 0.1 percentage points to 4.4%. That's still more than double the BoE's 2% target. Until this number starts to move, expect the BoE to be cautious with rate cuts.
What Happened
CPI fell to 3.0% in January from 3.4% in December: The same headline rate as January 2025 and a similar underlying pattern. CPI was falling through early 2025 too (hitting 2.6% in March) before the April 2025 policy shock – employer NICs, the minimum wage, and vehicle tax, compounded by a rise in the energy cap and water bills – pushed it above 3.5% and kept it there. The difference this time: there's no equivalent policy shock on the horizon. The November 2025 Budget was notably less inflationary than its predecessor, and lower wholesale energy costs – driven by falling global gas prices – are now working in inflation's favour.
The drop came almost entirely from goods: Goods inflation fell to 1.6%, with furniture in outright deflation (-0.5%) and motor fuels falling 2.2%. Services barely moved: 4.5% → 4.4%. Restaurants and hotels – the 3rd largest CPI division at ~11% of the total basket weight – was the only major division where inflation actually rose, from 3.8% to 4.1%, likely due to lagged effects from NIC increases and minimum wage.
Meanwhile the labour market is softening fast: Unemployment rose to 5.2%. Vacancies fell 8.4%. But wage growth is still running at 4.2%. That gap – loosening jobs market, sticky wages – is what's keeping services inflation elevated.
The Key Drivers
Goods inflation is falling fast
Goods inflation dropped to 1.6% from 2.2% in December. Furniture and household equipment is in outright deflation (-0.5%). Motor fuels fell 2.2%. Clothing is near zero. Global commodity prices have stabilised (in particular energy prices), supply chains are back to normal, and weak consumer demand is keeping discretionary goods prices down.
Government policy is the common thread in services inflation
The services components with the highest inflation all link back to government policy decisions. Council tax (5.4%), education (5.1%), restaurants and cafes (4.8%) each link to specific policy choices: local authority funding pressures, VAT on private school fees, and employer NICs and the minimum wage pushing up labour costs. Public sector wages are running at 7.0% – double the private sector's 3.5% – feeding directly into council tax, education, health, and transport costs. The 2025/26 pay round is already lower, so this effect starts to moderate from mid-2026.
There's a second-order effect too. Many services contracts – telecoms, rail fares, water – are pegged to CPI. When policy decisions push CPI up, those contracts automatically ratchet higher. Telecoms providers recently applied CPI + 3.9% increases, pushing communication inflation to 4.6%.
The labour market is loosening – wages haven't followed yet
Unemployment hit 5.2%, up from 4.4% a year ago. Vacancies dropped to 736,000 – down 8.4% year-on-year. Redundancies rose 27.7% to 145,000. There are now 2.6 unemployed people per vacancy, up from 1.9 a year ago.
Wages are a lagging indicator. There are early signs of a turn. December's single-month total pay growth was 3.0%, well below the 4.2% three-month average. Real pay in December fell 0.4%. The three-month average flatters the picture.
The Snapshot
UK inflation by component, January 2026 (CPIH 12-month rate)
What the table shows: Everything above the 3.2% CPIH line is predominantly services. Everything below is predominantly goods or energy. The gap between services (4.3%) and goods (1.6%) is 2.7 percentage points. The goods side of the economy has largely normalised. The services side – where most people work and most businesses operate – has not.
Electricity at 5.3% is an outlier. The overall Ofgem cap only rose ~1% year-on-year (£1,738 to £1,758) but underneath, electricity unit rates rose ~5% – driven by higher network and policy costs – while gas unit rates fell ~6%, offsetting each other in the headline cap figure. The cap is forecast to fall ~3% in April 2026.
So What
The economy needs rate cuts – but it may have to wait till May. In April 2025, CPI jumped 0.9 percentage points in a single month as employer NICs, the minimum wage, and vehicle tax hit alongside rising energy and water costs. That April 2025 spike drops out of the annual comparison in April 2026. Education's VAT effect is already unwinding (7.6% → 5.1%). By May 2026, CPI should be at or near the BoE's 2% target – the BoE's own forecasts say exactly this. But Q4 GDP grew 0.1%, services flatlined, and business investment fell 2.7% (see The UK’s Engine Stalled) – and services CPI is still 4.4%, which may keep the BoE cautious until then.
Wages haven't caught up with the weakening jobs market – but they're starting to. The jobs market is cooling fast – unemployment rising, vacancies falling, redundancies up. But wages always take time to follow. The three-month average (4.2%) still looks sticky. December's single-month figure (3.0%) tells a different story and it's one that matters. If that holds through Q1, services inflation should start to ease by mid-year. The sequence from there: fewer jobs → lower wage growth → lower services costs → lower inflation → BoE can cut.
Don't accept 'inflation' as a reason for price increases. Headline CPI is 3.0%, but that average hides two very different realities. Goods costs are falling – furniture is in deflation, motor fuels down 2.2%, clothing flat. If a supplier is trying to pass through 3-4% increases on materials or equipment, the data doesn't support it. Services are stickier, but not everywhere. Finance and business services wage growth is just 1.9% – the weakest of any sector. Professional services GDP contracted 1.1% for the second straight quarter. If someone is quoting you higher fees, ask what cost increase is driving it. In most cases, there isn't one.
One More Thing
The UK is Europe's inflation outlier. Germany's inflation is 2.1%. The Eurozone average is 1.7%. The UK's is 3.0%. The gap isn't about global forces – energy, food, and goods prices are moving in the same direction everywhere. It's the UK-specific policy decisions that account for most of the difference. Strip those out and UK inflation would likely look a lot more like the rest of Europe. That's where it's heading once the one-offs wash out.
Next Week
UK retail sales data on Friday will show whether the consumer is still spending despite falling real pay and a weakening jobs market.
The February flash PMI and GfK consumer confidence numbers land next week – a read on whether business and consumer confidence are aligned or diverging.