Borrowing costs fall and pound rises after inflation surprise
2025-01-16
Category: economic

Borrowing costs for the UK government have plunged, as an unexpected drop in inflation at home and in the US raised bets that central banks will cut interest rates in the months ahead.The yield - or interest rate - charged on key UK government debt dropped below 4.8%, retreating after last week's surge, when it had hit the highest level in 16 years. The moves followed new figures showing inflation cooled to 2.5% in December, from 2.6% in the prior month.It has eased pressure on Chancellor Rachel Reeves whose Budget policies have been criticised for contributing to the market turmoil.
UK bond yields soared to their highest levels since 2008 last week, as concerns over the UK's economic outlook and rising borrowing costs spiked. The yield on 10-year gilts, as bonds issued by the UK government are known, had been approaching 4.9%, reflecting investor unease.But government data on Wednesday, which showed inflation dropping for the first time in three months, appeared to help calm the market somewhat. 
Analysts said the ease in inflation would give the Bank of England more leeway to consider additional rate cuts to support the economy.Investors on Wednesday increased bets on the likelihood of an interest rate cut next month and are backing a second cut by the end of this year.Bets on lower borrowing costs were also bolstered by inflation news coming out of the US, where data suggested the underlying pace of price increases was easing. The monthly report from the Labor Department showed overall inflation rose to 2.9% in December, up from 2.7%. But markets focused on so-called core inflation, which excludes volatile food and energy costs and is seen as a better indicator of the trends.That metric fell unexpectedly from 3.3% to 3.2%, raising hopes the US central bank would cut interest rates in the months ahead.Share prices jumped and yields in the US fell, moves that quickly rippled out to global bond markets, where borrowing costs had been rising in reaction to the dynamics in the US. Germany was among the countries in addition to the UK where yields on government debt fell. The pound also rose in reaction to the news, to stand around $1.22.However, Susannah Streeter, head of money and markets at Hargreaves Lansdown warned that borrowing costs for the UK remain high, despite today's relief."Government borrowing costs have begun to edge downwards, with the yield on 10-year gilts heading lower, but it remains above 4.8%, at multi-decade highs as investors assess Britain's debt burden," she said. 