The pound fell to a 10-month low and stocks rallied as a surprise drop in inflation raised hopes that interest rates may have already peaked.
In a report that surprised the city, the Office for National Statistics said inflation fell to 6.7 percent in August from 6.8 percent in July.
The figures sent shockwaves through the financial sector and contradicted forecasts that inflation would rise to 7 percent or even higher.
Analysts say this could be enough to prevent the Bank of England from raising interest rates today, with the decision now on a knife edge.
Sterling fell as low as $1.2335 or 1.1549 euros, while British government bond yields – a key measure of the cost of government borrowing – also fell.
Inflation shock: Sterling fell as low as $1.2335 against the US dollar before recovering after latest figures showed inflation fell to 6.7% in August from 6.8% in July
At the same time, house builders and commercial property developers led the stock market higher, with the FTSE 100 rising 0.9 percent to 7,731.65 and the FTSE 250 rising 1.6 percent to 18,712.37.
High street retailers also hit the ground running, hoping the pressure on family finances could finally come to an end.
Goldman Sachs forecast that the bank’s Monetary Policy Committee (MPC) will leave interest rates unchanged at 5.25 percent today.
“We now expect the MPC to leave the key interest rate unchanged and lower our forecast for the key interest rate to 5.25 percent from 5.5 percent,” the US bank said in a report.
George Buckley, an economist at Nomura, added: “We don’t expect any change in interest rates at this time.”
Policies are restrictive and both the economy and now inflation are reacting. The time feels ripe for a break.’
Others suggested that a rate hike today – to 5.5 percent – would be the last. Paul Dales, chief UK economist at Capital Economics, said: “The unexpected fall in inflation is unlikely to be enough to stop the Bank from raising rates to 5.5 per cent tomorrow.” But it confirms our view that this is the last “It will be a hike.”
Among the biggest stock market winners were housebuilders: Crest Nicholson rose 5.8 per cent or 10.5p to 190.8p, Taylor Wimpey rose 5.6 per cent or 6.4p to 121.7p, Barratt Developments rose by 4.7 percent or 21 pence. to 465.5p, Bellway rose 5 per cent or 108p to 2268p and Persimmon rose 5.1 per cent or 53.5p to 1100p.
Property developer British Land rose 3.9 per cent, or 12p, to 321.1p and rival Land Securities rose 4.1 per cent, or 23.6p, to 606.4p, while budget retailer B&M rose 4 per cent, or rose 22.2p to 579p and B&Q owner Kingfisher rose 4.3 per cent or 8.9p to 215.7p.
Russ Mold, investment director at AJ Bell, said: “Weaker inflation feeds the argument that interest rates no longer need to rise, or at least not much more.”
“This would be beneficial for both property-related businesses and retailers as consumers would, in theory, no longer face additional pressure on their finances.”
“We could get another rate hike from the Bank of England, but the latest inflation data increases the chance that another rate hike could be the last in the current cycle.”
The bank has already raised interest rates from 0.1 percent to 5.25 percent since December 2021 in order to bring inflation back under control.
But despite falling from a peak of 11.1 percent in October last year to 6.7 percent last month, inflation is still more than three times above the 2 percent target.
Until yesterday, it was widely expected that the bank would raise interest rates to 5.5 percent today, with financial markets suggesting there was an 80 percent chance of such a move. Last night the value was estimated at 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 did the decline in inflation in the services sector: prices were 6.8 percent higher in August than a year earlier, compared to the 7.4 percent increase in July.
But Interactive Investor’s Victoria Scholar said oil prices remained a “key risk” to the outlook even as inflation falls – suggesting interest rates are at or near their peak.
Oil prices hit a 10-month high of over $95 a barrel this week – driving up fuel costs for drivers and airlines.
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