In a week where UK inflation fell, US inflation picked up. Bond markets were busy digesting how this might impact interest rate cuts going into 2025, as we continue to see volatility in markets.
UK inflation dropped to 2.5% in December, down from 2.6% in November. The slowdown was driven by services inflation, which eased to 4.4% from 5%. Airfares and accommodation prices were the biggest contributors to the move.
Following on from last week’s spike in gilt yields, this week the volatility continued. Elevated bond yields often signify inflation worries. This can lead to higher borrowing costs for governments and individuals, and can potentially dampen economic growth.
It is important to note that bond yields and prices are inversely correlated. What appears to be a small yield increase in longer duration gilts can result in multiple digit capital losses.
Over in the US, inflation accelerated to 2.9% as the price of fuel, eggs and used cars rose. However, underlying price pressures also showed signs of easing, fueling hopes that the Federal Reserve can cut rates earlier than anticipated this year.
Core inflation which excludes volatile prices of food and energy declined to 3.2% after a three month print of 3.3%. Economists pay close attention to core inflation as it usually provides a better guide of inflation’s path.
Now, we turn our attention to interest rate expectations, although the changes are small compared to last week’s expectations. The market is pricing in more forceful rate cuts on the back of stronger than expected job numbers and stable inflation data.
Non-farm-payrolls for December crushed expectations at +256k jobs added versus the expected +160k, leading to a strengthening of the US Dollar.
Heading into Trump’s inauguration week, policymakers remain concerned about inflation and the potential impact of Trump’s policies. Although the Federal Reserve and the White House operate independently of each other, the uncertainty going into the new presidency remains, leading to a more cautious move on interest rates.
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