Rachel Reeves was being written off in some headlines as a “lame duck” chancellor earlier this week, after a savage bond sell-off put her at risk of breaking her fiscal rules.
The shadow chancellor, Mel Stride, had even compared Reeves’s situation – somewhat bafflingly – to Hamlet, Shakespeare’s tragic prince, while the Tory leader, Kemi Badenoch, claimed Labour had chosen a chancellor who wasn’t “qualified to do the job”.
Yet what financial markets take away, they can restore. After Wednesday morning when UK inflation come in at a lower-than-expected 2.5%, most of the increase in bond yields of recent days was reversed.
If maintained, the sharp jump in the yield on government bonds, known as gilts, could have wiped out the £9.9bn of headroom Reeves left herself to meet her fiscal rules, by pushing up the cost of government borrowing. Treasury insiders were dropping heavy hints that if that happened, Reeves could respond with spending cuts.
That fevered debate of recent days should now abate, at least for a while, allowing Reeves and her ministerial colleagues some space in the news agenda to trumpet their plans for growth.
And after the surprise easing in the inflation rate, the Bank of England’s nine-member monetary policy committee (MPC) looks highly likely to cut interest rates to 4.5% at its next meeting on 6 February, potentially injecting a much-needed bit of feelgood factor into the flagging economy.
It helped market sentiment, too, that US inflation data, also released on Wednesday, came in exactly in line with investors’ expectations, calming fears of a resurgence in price pressures.
Much of the jump in bond yields in the UK, which move in the opposite direction to prices, has echoed similar shifts in the US, where markets are braced for Donald Trump’s arrival in the White House next week.
While the sell-off had been driven by global concerns, however, part of it related to fears that the UK was sliding towards “stagflation” – a nasty combination of slow growth and sticky prices.
December’s consumer price index (CPI) reading for the UK of 2.5%, down from 2.6% in November, helped to calm those worries somewhat.
In particular core inflation, which strips out the volatile elements of energy, food, alcohol and tobacco, fell to 3.2% in December, down from 3.5% a month earlier. These domestically generated price increases are the ones the Bank tends to fret about the most.
The cost of a night out or a weekend away in December seems to have been a key part of the picture: the Office for National Statistics singled out hotels and restaurants as a driver of the slide in the CPI.
after newsletter promotion
On an annual basis, inflation in restaurant and hotel prices was 3.4% – down from 4% a month earlier, and the lowest since July 2021, when the economy had not fully reopened after the pandemic.
Food prices, which were a significant source of inflationary pressure through 2022 and 2023, were up by 2% in the year to December – unchanged from November.
Retailers have warned that they may increase prices in the months ahead, as changes announced in Reeves’s budget, including the £25bn rise in employer national insurance contributions, push up business costs from April. But for the moment, CPI inflation appears to be heading in the right direction.
The markets’ focus will now switch to Thursday’s gross domestic product data for November: a test of the growth part of the stagflation picture.
A worse-than-expected reading could yet spark another market wobble in the days ahead; but for the time being, Reeves can return to banging the drum for growth.
