UK inflation unexpectedly fell in December, handing some breathing space to the chancellor, Rachel Reeves, after a week of turbulence in financial markets.

With the government under pressure on the economy, figures from the Office for National Statistics showed the consumer prices index eased to 2.5%, below a reading of 2.6% in November, meaning prices rose at a slower rate.

City economists had forecast inflation would remain unchanged on the previous month. However, inflation remained above the Bank of England’s 2% target, while experts warned it could rise above 3% before the end of this year.

Grant Fitzner, the ONS chief economist, said: “Inflation eased very slightly as hotel prices dipped this month, but rose a year ago. The cost of tobacco was another downward driver, as prices increased by less than this time last year.

“This was partly offset by the cost of fuel and also secondhand cars, which saw their first annual growth since July 2023.”

In a crunch economic update just as the government battled to reassure jittery bond market investors, the latest snapshot could open the door for the Bank to cut interest rates as early as next month.

The pound fell by about 0.3% against the dollar to below $1.22 shortly after the figures were released.

In response to the December inflation figures, Reeves said: “There is still work to be done to help families across the country with the cost of living. That’s why the government has taken action to protect working people’s payslips from higher taxes, frozen fuel duty and boosted the national minimum wage.

“In our ‘Plan for Change’, we were clear that growth is our number one priority to put more money in the pockets of working people. I will fight every day to deliver that growth and improve living standards in every part of the UK.”

The latest snapshot showed core inflation – which excludes volatile items such as energy, food, alcohol and tobacco – rose at a slower rate than expected in December, cooling from 3.5% in November to 3.2%. Services inflation, which is closely watched by the Bank of England, also fell, from 5% to 4.4%.

Threadneedle Street had signalled it would take a gradual approach to cutting borrowing costs after inflation fell from a peak of more than 11% in late 2022, when soaring energy prices fuelled a surge in the cost of living. UK interest rates stand at 4.75%, after cuts in August and November last year.

However, analysts have warned that sticky inflation could derail cuts from the central bank despite stalling economic growth. Investors also warn that Reeves could be forced to U-turn on a pledge not to increase taxes should sustained higher borrowing costs threaten to break her fiscal rules.

The chancellor on Tuesday signalled she was prepared to make emergency spending cuts to balance the books if required, while arguing her priority was to go “further and faster” to boost economic growth in an effort to placate financial markets.