Economists had widely expected the rate to rise from 2.5 per cent to 2.8 per cent in the latest Office for National Statistics (ONS) figures released on Wednesday.
Before Wednesday, traders were fully pricing in two further cuts to interest rates this year, which would take the level of the Bank of England base rate to 4 per cent.
Although inflation has been forecast to rise to 3.7 per cent by the middle of this year, the higher than expected increase means economists fear it could remain stickier for longer.
Higher taxes for businesses and the increase in the minimum wage, which were announced in last October’s Budget, will come into force in April and are expected to contribute to higher inflation as costs are passed on to the consumer.
Roger Barker, director of policy at the Institute of Directors, said: “The latest figures cast doubt on the pace of future interest rate cuts, which the Bank of England may choose to delay due to the persistence of inflationary pressures.”
Sam Miley, forecasting lead at the Centre for Business and Economics Research (CEBR) said: “Today’s data alongside other recent developments, such as the Bank of England’s February Monetary Policy Report (which cut growth forecasts and suggested inflation would peak at 3.7 per cent) and the volatility in gilt markets in January, have contributed to a change in our outlook for interest rates this year.
Provider: PA WireRuth Gregory, deputy UK chief economist at Capital Economics said: “The upside surprise in January shouldn’t have too much of an effect on the Monetary Policy Committee’s (MPC) view on where interest rates need to be.
The Bank of England cut interest rates from 4.75 per cent to 4.5 per cent earlier this month, partly to help boost the UK’s struggling economy which some analysts fear is at the risk of stagflation – weak growth and high inflation.
Low growth will hamper the Chancellor’s efforts to stick to her fiscal rules where by day-to-day spending is met by taxation rather than borrowing. With the Chancellor’s financial headroom of £9.9bn thought to have been wiped out, Reeves is facing having to make cuts to public services in her fiscal statement on March 26, or raise taxes.
Several economists pointed to softer services inflation as a reason for not cutting their overall forecasts, suggesting that although it rose from 4.4 to 5 per cent, this was still below predictions.
“Despite headline inflation coming in hotter-than-expected, the number that matters more for the MPC is services inflation, which was actually a little softer than the latest MPC forecast (5 per cent vs 5.2 per cent).
Deutsche Bank Research is still forecasting four more cuts to interest rates this year, but its chief UK economist Sanjay Raja said: “We think the chances of a temporary pause [in cuts] through the second quarter of the year remains elevated – especially given the upside risks still prevalent in the economy over the next few months.”
Slower cuts would mean larger costs for those on variable mortgages, that drop when interest rates do.
Cheapest mortgage rates could 'vanish' after inflation climbs to 3%
Read MoreIf markets start to expect fewer interest rate cuts, this can be reflected in swap rates, which impact the cost of fixed mortgages.
Lewis Shaw, a mortgage broker at Shaw Financial Services, said: “Today’s inflation figures make for dire reading, and the UK bond market’s reaction will be the key driver of how long the new sub-4 per cent mortgage deals are around.
The Chancellor said: “Getting more money in people’s pockets is my number one mission. Since the election we’ve seen year-on-year wages after inflation growing at their fastest rate in three years – worth an extra £1,000 a year on average – but I know that millions of families are still struggling to make ends meet.
“That’s why we’re going further and faster to deliver economic growth. By taking on the blockers to get Britain building again, investing to rebuild our roads, rail and energy infrastructure and ripping up unnecessary regulation, we will kickstart growth, secure well-paid jobs and get more pounds in pockets.”
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