UK inflation fall sparks Santa rally: Rate cut hopes boost shares and gilts

Shares rose and bond yields fell as investors cheered a sharper-than- expected fall in inflation.

The ‘Santa rally’ was driven by intensifying speculation that, with inflation in retreat, the Bank of England could cut interest rates as many as six times in 2024 to less than 4 per cent by this time next year.

In stocks, the FTSE 100 hit its highest level since May before giving up some gains, but it still finished 77.65 points, or 1 per cent, higher at 7715.68.

And yields on UK ten-year bonds, which go down as their prices rise, fell close to 3.5 per cent – the lowest since April.

Markets globally have been in exuberant mood since the US Federal Reserve last week signalled a series of rate cuts for 2024 in what was seen as a significant ‘pivot’.

Yesterday, Wall Street stocks took a breather after hitting record highs.

But bond markets in the US and Europe followed Britain’s rally. US ten-year Treasury yields hit a five-month low and Germany’s ten-year bond yields fell below 2 per cent for the first time since March.

It came as the Office for National Statistics said that the UK’s inflation fell to 3.9 per cent in November, which was down from 4.6 per cent in October.

That was the lowest level since September 2021 and well below the 4.4 per cent expected by economists. The decline was driven by falling fuel prices as well as slowing food inflation.

Markets now see a 50/50 chance of the Bank of England cutting interest rates as early as March next year, from 5.25 per cent to 5 per cent, and a near-80 per cent chance of a cut by May.

Traders are betting on a succession of rate cuts, with a 50 per cent chance that they could be as low as 3.75 per cent by this time next year.

That put pressure on the pound, which fell by a cent to just over $1.26 versus the dollar before making up some ground. 

Neil Wilson, chief market analyst at Finalto, said the inflation figures were ‘a Christmas gift for the chancellor, the Bank of England and the economy’.

On the stock market, retailers Marks & Spencer, Ocado and B&Q owner Kingfisher were up more than 2 per cent.

Bond investors, meanwhile, are betting on the UK having to cut rates as the economic outlook darkens.

They include bond trader Pimco, which has said Britain risked a ‘hard landing’.

Luke Hickmore, investment director at Abrdn, said the inflation data said a lot about how weak the UK economy is.

He believed rates would be cut in the UK before the US, where inflation is 3.1 per cent but no longer seeing such sharp declines.

Pantheon Macroeconomics experts think inflation in Britain will fall faster than predicted by the Bank of England, hitting the 2 per cent target by May.

Investec economist Sandra Horsfield suggested that the Bank’s insistence that interest rates will have to stay higher for longer would soon change.

‘The message until now from the monetary policy committee (MPC) had been to push back against ever more exuberant market expectations of rate cuts,’ she said.

‘With the facts changing before the MPC’s eyes, some softening in the rhetoric seems almost assured in 2024 – even if the MPC will not want to see rate cut expectations going too far and loosening financial conditions so far as to threaten progress on inflation.’