UK inflation slide fuels rate cut bets and jolts markets

LONDON — U.K. inflation fell by more than expected to hit 3.9% in November, in the lowest annual reading since September 2021.

Economists polled by Reuters had expected a modest decline in the headline consumer price index to 4.4%, after the 4.6% annual reading of October surprised to the downside by dropping to a two-year low.

Month on month, the headline CPI fell by 0.2%, compared with a consensus forecast of a 0.1% increase.

The Core CPI — which excludes volatile food, energy, alcohol and tobacco prices — came in at an annual 5.1%, well below a 5.6% forecast.

The surprisingly large falls prompted a spike in bets that the Bank of England will cut interest rates in 2024, which manifested in a sharp fall in British bond yields.

The yield on the U.K. 10-year government bond, or gilt, sunk to an eight-month low, dropping 11 basis points to around 3.54%. Yields move inversely to prices. Meanwhile, the U.K.’s FTSE 100 was the only major European stock index in positive territory on Wednesday, climbing 0.8% by midmorning London time.

The Office for National Statistics said the largest downward contributions came from transport, recreation and culture, and food and nonalcoholic beverages.

The Bank of England last week maintained a hawkish tone as it kept its main interest rate unchanged at 5.25%. The Monetary Policy Committee reiterated that policy is “likely to need to be restrictive for an extended period of time.”

The central bank ended a run of 14 straight interest rate hikes in September, as policymakers looked to wrestle inflation back down toward the bank’s 2% target from a 41-year high of 11.1% in October 2022.

U.K. Finance Minister Jeremy Hunt cheered the Wednesday figures and said the country was “starting to remove inflationary pressures from the economy.”

“Alongside the business tax cuts announced in the Autumn Statement this means we are back on the path to healthy, sustainable growth,” he said in a statement.

“But many families are still struggling with high prices so we will continue to prioritise measures that help with cost of living pressures.”

Significant fall ‘undermines’ Bank of England caution

The Bank of England has repeatedly pushed back against market expectations for significant cuts to interest rates in 2024, noting last week that “key indicators of U.K. inflation persistence remain elevated.”

Suren Thiru, economics director at ICAEW, said the “startling” fall in inflation recorded Wednesday will reassure households that there is a “light at the end of the tunnel,” with easing core CPI figures showing that underlying price pressures are relenting.

“The likely squeeze on wages from rising unemployment and a stagnating economy should help to continue to keep them on a downward trajectory,” he said by email.

“These inflation numbers suggest that the Bank of England is too pessimistic in its rhetoric over when interest rates could start falling. A deteriorating economy could push the Bank to start loosening policy by the Autumn, particularly if inflationary pressures continuing easing.”

A ‘glimmer of relief’

Richard Carter, head of fixed interest research at Quilter Cheviot, said the latest inflation print adds to a sense of “cautious optimism” in the U.K. relative to the cost-of-living crisis and bond market chaos of last year.

Despite the drop in CPI, he noted that the broader economic picture remains “complex, marred by stagnation and subdued growth prospects.”

The U.K. economy contracted by 0.3% month on month in October, after flatlining in the third quarter.

“This stagnation, leaving the output no higher than it was in January, paints a picture of an economy struggling to rebound from a series of unprecedented challenges,” Carter said over email, while acknowledging that the pace at which inflation is slowing offers a “glimmer of relief” for households.

“The pressures are manifold – from the cost of living crisis, volatile energy markets, Brexit aftershocks, to enduring productivity issues. These factors have collectively dampened economic prospects and consumer confidence.”