The shock rise in inflation has shattered hopes of early rate cuts

After an unexpected increase in inflation, the FTSE 100 dropped by up to 2 percent. This dashed any hopes for an early interest rate cut.

After official data revealed that consumer price growth in December had risen to 4% from 3.9 % the month before, the sell-off of London’s premier share index reversed a year-long trend of monthly declines. Analysts in the City had predicted a drop to 3.8%, but tobacco and airline fares pushed it up.

The yield on the benchmark 10-year gilt increased by 0.17 percentage points, reaching 3.98 percent.

The FTSE 100 experienced its worst trading day since August, wiping out tens of billions in value. It managed to pare losses and end the volatile session at 7,446.30 down by 112.05 or 1.5 percent. This is its lowest closing price since last November. The domestically-focused FTSE 250 lost 328.9 or 1.7% to close the day at 18,864.37.

The Stoxx 600 fell 1.1 percent, Germany’s Dax 40 dropped 0.8 percent, and France’s CAC 40 was down 1.1 percent. This is because the markets were spooked by Christine Lagarde’s statement that the European Central Bank president said interest rates would not fall until the summer.

The pound gained nearly 0.2% against the US Dollar to $1.265, while the euro rose by 0.4% to €1.166 amid expectations that Bank of England would keep its interest rates at higher levels for longer.

Investors had predicted that inflation would drop rapidly to the official target of 2 percent in the first half of the year. This allowed the Bank to cut interest rates from the 5.25 percent, which was a 15-year record, in May. Deutsche Bank, Oxford Economics ING, and Investec all forecast that the Bank’s inflation target will be reached or is very close to it by spring.

The latest figures for Britain, the Eurozone, and the United States show that inflation has risen again in December. This suggests that it will be difficult to bring inflation under control sustainably in the big developed economies.

James Smith, developed market economist at ING said that a surprise increase in inflation showed that “the market may have priced a rate cut in May too early”. He also predicted that the Bank of England would begin to loosen policy in August.

Thomas Pugh, RSM UK’s economist, stated that the Bank of England had not expected services inflation to rise to 6.4% from 6.34%. This means “that a first rate cut could still be coming in May”.

Jeremy Hunt, chancellor of the United Kingdom, said that inflation doesn’t fall in a straight-line, as we have seen it in France, Germany and the US. But our plan works and we should keep to it.

In Britain, a steep increase in the price of tobacco products as a result a rise in sales tax and a sharp hike in air fares pushed headline inflation up last month. The peak was at 11,1 per cent in October of 2022. In December, food prices fell to 8 percent from 9.2 percent.

Andrew Bailey, Governor of the Bank of England and the Bank of England’s monetary committee, the nine member group responsible for setting the Bank of England’s base interest rate have rejected market expectations of sweeping rate cuts. The MPC insists that it will keep the financial conditions restrictive for an “extended time”. Analysts in the city expect that the MPC will soften this guidance at its February 1 meeting, potentially opening the door to interest rate reductions from May.