FTSE 100 rises and gilts recover but Reeves isn’t out of the woods just yet
Chancellor Rachel Reeves was dealt some welcome good news after a surprise drop in inflation that saw gilt yields fall at the fastest pace in over a year on Wednesday, but some economists fear the development represents a temporary reprieve with inflation at risk of rebounding in the coming months.
New figures from the Office for National Statistics (ONS) put the headline rate of inflation at 2.5 per cent in December, down from 2.6 per cent the month before.
Services inflation – a good gauge of homegrown price pressures – slipped to 4.4 per cent. This was down from 5.0 per cent in November and well below the 4.8 per cent expected by City experts.
Michael Brown, senior research strategist at Pepperstone, said the figures will come as a “significant relief” to both Rachel Reeves and Bank of England governor Andrew Bailey following serious jitters in the UK gilt market.
Investors moved to fully price in two interest rate cuts in the UK for 2025, helping to ease the pressure on gilts.
US inflation also came in slightly below expectations. Although the headline rate rose to 2.9 per cent, core inflation softened to 3.2 per cent, down from 3.3 per cent in November.
“The compound effect of the US and UK CPI reports, which were both better than expected, has had a profound effect on the bond market,” Kathleen Brooks, research director at XTB said.
Gilts, rates and housebuilders
Following the figures, the yield on the 10-year gilt fell by as much as 16 basis points to 4.73 per cent while the yield on the rate-sensitive two-year gilt also shed 12 basis points, falling to around 4.5 per cent.
According to Bloomberg, this was the largest fall on the 10-year yield since 2023, although it still left the yield well ahead of where it was just a couple of weeks ago.
Equities also marched higher on Wednesday, with housebuilders benefiting from hopes that the Bank of England would cut rates at a faster pace.
The FTSE 100 rose 0.88 per cent with Persimmon, Taylor Wimpey, Barratt and Berkeley all among the blue-chip’s top risers.
The FTSE 250, which is more aligned with the health of the domestic economy, climbed 2.3 per cent to trade at 20,213.37, with housebuilders also among the top performers.
“Housebuilders are on the front foot, as interest rate cuts are forecast to come a little more swiftly. That’s expected to accelerate the recovery we’ve seen in the housing market,” Susannah Streeter, head of money and markets, Hargreaves Lansdown said.
But a number of economists pointed out that the fall in inflation was largely driven by erratic movements, such as airfares and hotels, which might limit the extent of rate cuts going forward.
Airfares increased at the third lowest rate since monthly prices were first collected in 2001, the ONS said, largely because of the dates on which the data was gathered.
This single movement explained “about half” of the fall in core inflation, according to Pantheon Macroeconomics.
“The dovish news today is a temporary reprieve,” Rob Wood, chief UK economist at the consultancy said, predicting prices would bounce back in January.
The data could also signal that the economy is weakening, Kallum Pickering, chief economist at Peel Hunt, suggested.
“If the cause of the softer momentum in prices during December is that a sudden drop-off in demand has sapped firms’ pricing power, the risk to watch now is that incoming data on the real economy surprise to the downside,” he said.
Sterling
Sterling also received a boost on Wednesday, climbing 0.7 per cent against the dollar to trade at just under $1.23.
The pound fell to its lowest level against the dollar in over a year last week due to concerns about the UK’s economic outlook.
Normally the prospect of lower interest rates would weaken the pound, because it means investors receive less of a return on their investments, but – as Brooks noted – “these are not normal times for UK assets”.
She suggested the pound could stage a “short-term relief rally” because it was likely to ease fears about stagflation.
Weaker inflation in the US also raises the possibility of slightly faster rate cuts from the Fed, which would support the pound relative to the dollar.