Sterling weakened and UK government bonds rallied after UK inflation fell more than forecast to a five-month low, raising the chances that interest rate rises would pause sooner than investors had previously expected.
Data on Wednesday showed UK inflation slowed to 10.1 per cent in January, more than expected. Core inflation fell to 5.8 per cent, much lower than the 6.2 per cent forecast by economists. London’s FTSE 100 was flat and sterling shed 0.6 per cent against the dollar to $1.209.
The inflation figures have boosted expectations that the Bank of England will pause its monetary tightening campaign later in the spring, and come as the UK teeters on the edge of recession. The UK economy stagnated in the final quarter of 2022 after contracting in the previous three months.
Having risen steadily since early February, two-year gilt yields fell 0.11 percentage points to 3.69 per cent following Wednesday’s inflation figures, while 10-year gilt yields fell by 0.1 percentage points to 3.41 per cent. Bond yields move inversely to prices.
The BoE this month increased interest rates by half a percentage point to a 15-year high of 4 per cent, but it hinted that February’s increase might be its last.
Services inflation had “probably peaked”, said James Smith, developed markets economist at ING, who added he still expected a quarter percentage point rate increase in March, but that there would be a “strong argument” in favour of pausing in May if inflation continued to slide.
Tuesday’s stronger than expected US inflation figures dominated investor attention elsewhere.
Europe’s region-wide Stoxx 600 added 0.2 per cent and Germany’s Dax rose 0.4 per cent as fund managers and economists digested news that US consumer prices rose 6.4 per cent year on year in January, more than expected. Annual core inflation, which strips out volatile food and energy prices, was also slightly above expectations.
The disappointing US data reverberated throughout financial markets, raising the level at which investors expect US rates to peak and lowering the number of rate cuts forecast for later this year. Pricing in the futures market shows traders expect rates to peak at 5.27 per cent in July, up from 5.18 per cent before the data was released. A measure of the dollar’s strength against a basket of six peers gained 0.3 per cent.
Futures on Wall Street’s benchmark S&P 500 and those tracking the tech-heavy Nasdaq 100 fell 0.4 per cent ahead of the US open.
“[A] slowing of inflation progress . . . means we get to the 2 per cent target further out in the future, which means the [Federal Reserve] will stay higher for even longer,” said Mike Zigmont, head of trading and research at Harvest Volatility Management. “There is no urgency for the Fed to cut rates if inflation is taking longer to get down where the Fed wants it.”
Salman Ahmed, global head of macro at Fidelity International, said a combination of the slowing pace of inflation and resilience in the “super hot” US labour market — which added more than half a million jobs in January, almost triple the consensus forecast — meant the Fed “is likely to up its hawkishness” in the coming months.
US government bonds rallied on Wednesday as equities sold off, with the two-year Treasury yield falling 0.02 percentage points to 4.6 per cent. The 10-year Treasury yield declined 0.01 percentage points to 3.74 per cent as the price of the debt rose.
In Asia, Hong Kong’s Hang Seng index shed 1.4 per cent, China’s CSI 300 lost 0.5 per cent, Japan’s Topix declined 0.3 per cent and South Korea’s Kospi shed 1.5 per cent.
Prices for Brent crude, the international oil benchmark, slipped 1.2 per cent to $84.51 a barrel.