The main measure of inflation in the UK, at 2.5 per cent in December, came in 10 basis points lower than both the previous month and a consensus forecast.
Of particular note was the softer core and services prints, according to Oliver Faizallah, head of fixed income research at Charles Stanley. He said this may persuade some of the more hawkish Bank of England officials who have been reluctant to cut rates to consider voting in favour of a reduction in February.
Core CPI, which excludes energy, food, alcohol and tobacco, rose by 3.2 per cent in the year to December, down from 3.5 per cent in November. The CPI services annual rate also fell month-on-month from 5 per cent to 4.4 per cent, the lowest rate since March 2022.
Minutes of the most recent monetary policy committee meeting, published in December before the latest CPI release, stated that headline CPI inflation was expected to continue to rise slightly in the near term.
Faizallah said this suggests the data could come as a “downside surprise” to the BoE. “The main reason for the undershoot was weaker-than-expected services inflation, a key metric for the BoE,” he added.
While this provided support for gilts, Faizallah said the longer-term trajectory will still be dictated by UK and US fiscal policy, and the fact that underlying movements in gilt yields are heavily influenced by movements in US yields.
“That means the trajectory of US Treasury yields, and any announcements surrounding the UK government’s fiscal policy, will likely remain a key driver for gilts going forward,” he said.
Rupert Thompson, chief economist at Iboss, a discretionary fund manager, said that in both the UK and US, headline and core inflation are down sharply from their highs.
“Core inflation is a bit higher than headline inflation in both countries. And the services sector remains the main source of residual inflation pressure, running at 4.4 per cent in both countries.
“Given the closeness of the inflation picture, it isn’t a big surprise that the US Federal Reserve and BoE plans to cut rates are also quite alike. The market is currently pricing in UK rates falling by 0.5 per cent to 0.75 per cent by year-end, and US rates declining by 0.25 per cent to 0.5 per cent.
“Given that in the US growth is considerably stronger and tariff hikes may also boost inflation, the prospect of slightly larger rate cuts in the UK makes perfect sense.”
Thompson added: “With the inflation and interest rate backdrop looking very similar, you would expect government bond yields in the US and UK also to be close, and they are. Two and 10-year yields are around 4.2 per cent and 4.6 per cent respectively in both economies.”
Tom Hopkins, a senior portfolio manager at BRI Wealth Management, likewise pointed to core inflation in the US and UK showing a slight decline to 3.2 per cent in December, down from 3.3 per cent and 3.5 per cent respectively.
“This moderation supported bond markets, with falling US Treasury and gilt yields,” he said. “However, inflation has remained stable over the past six months, making a significant downtrend unlikely in the near term.”
chloe.cheung@ft.com
