The pound fell to a ten-month low and stocks rallied as a surprise drop in inflation raised hopes that interest rates have already peaked.
In a report that took the city by surprise, the Office for National Statistics said inflation fell from 6.8 per cent in July to 6.7 per cent in August.
The figures shocked the financial sector and countered forecasts that inflation would rise to 7 percent or even higher.
Analysts said it could be enough to stop the Bank of England from raising interest rates today, with the decision now on a knife edge.
Sterling fell to $1.2335 and €1.1549, while bond yields (a key measure of government borrowing costs) also fell.
Inflation shock: Sterling fell as low as $1.2335 against the US dollar before recovering, after the latest figures showed inflation fell from 6.8% in July to 6.7% in August.
At the same time, housebuilders and commercial property developers led the stock market, with the FTSE 100 up 0.9 per cent to 7,731.65 and the FTSE 250 up 1.6 per cent to 18,712.37.
High Street retailers were also on the move in the hope that the squeeze on household finances is finally coming to an end.
Goldman Sachs predicted that the Bank’s Monetary Policy Committee (MPC) will leave rates unchanged at 5.25 percent today.
“We now expect the MPC to keep the bank rate unchanged and reduce our forecast for the terminal policy rate to 5.25 percent from 5.5 percent,” the US bank said in a report.
George Buckley, economist at Nomura, added: “We now don’t expect any change in rates.
Policy is restrictive and both the economy and now inflation are responding. It seems that the time has come to take a break.
Others suggested that a rate increase today – to 5.5 percent – would be the last. Paul Dales, chief UK economist at Capital Economics, said: “Unexpected falls in inflation are unlikely to be enough to prevent the Bank from raising rates to 5.5 per cent tomorrow.” “But it supports our view that it will be the last increase.”
Among the biggest stock market gainers were housebuilders: Crest Nicholson gained 5.8 per cent, or 10.5p, to 190.8p, Taylor Wimpey rose 5.6 per cent, or 6.4 pence, to 121.7 pence, Barratt Developments rose 4.7 per cent, or 21 pence. at 465.5p, Bellway jumped 5 per cent, or 108p, to 2,268p and Persimmon rose 5.1 per cent, or 53.5p, to 1,100p.
Property developer British Land gained 3.9 per cent, or 12 pence, to 321.1 pence and rival Land Securities added 4.1 per cent, or 23.6 pence, to 606.4 pence, while the Budget retailer B&M jumped 4 per cent, or 22.2 pence, to 579 pence and B&Q-owner Kingfisher soared 4.3 per cent, or 8.9 pence, to 215.7 pence.
Russ Mould, chief investment officer at AJ Bell, said: “Weaker inflation fuels the argument that interest rates no longer need to rise, or at least not much higher.”
‘This would be positive for both property companies and retailers, because in theory consumers would no longer face additional pressures on their finances.
“We could still get another rate hike from the Bank of England, but the latest inflation data raises the possibility that a new rate hike will be the last of the current cycle.”
The Bank has already raised rates from 0.1 percent to 5.25 percent since December 2021 in a bid to bring inflation back under control.
But while inflation has fallen from a high of 11.1 percent in October last year to 6.7 percent last month, it is still more than three times higher than the 2 percent target.
Until yesterday, the Bank was widely expected to raise rates to 5.5 percent today, with financial markets suggesting there was an 80 percent chance of such a move. Last night it was around 50-50.
The fall in core inflation – which excludes food and energy prices – from 6.9 percent to 6.2 percent was seen as a particularly welcome sign that price pressures are easing.
As has falling inflation in the services sector, with prices in August 6.8 percent higher than a year earlier, down from the 7.4 percent increase seen in July.
But Interactive Investor’s Victoria Scholar said that while inflation is falling (indicating interest rates are at or near their peak), the oil price remains a “key risk” to the outlook.
Oil hit a ten-month high above $95 a barrel this week, raising the cost of fuel for motorists and airlines.
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