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UK bonds sell off as inflation in April falls less than expected

UK bond markets sold off on Wednesday and traders pencilled in further interest rate rises after inflation fell much less than the Bank of England had forecast.

The Office for National Statistics said consumer price inflation fell to 8.7 per cent in April — down from 10.1 per cent in March but significantly above the BoE’s forecast of 8.4 per cent.

Government borrowing costs shot higher on the figures as traders revised their expectations of interest rates upwards.

The yield on two-year gilts shot up 0.22 percentage points to 4.35 per cent, pushing them towards rates last seen after Liz Truss’s unfunded 2022 “mini” Budget wreaked havoc in financial markets.

Traders in forward markets are now betting that rates will peak at about 5.3 per cent by the end of the year.

“It’s clearly a big surprise for the entire community and we’ve seen a big reaction,” said Peter Schaffrik, economist at RBC Capital Markets. “It’s very difficult to say with any degree of confidence that this environment will change in the near term — the UK labour market is still extremely tight.”

While a substantial drop had been widely anticipated because of the impact of factoring out energy price increases early last year, core inflation for April rose to 6.8 per cent, from 6.2 per cent the month before.

Food price inflation remained close to its 45-year peak, at 19.1 per cent compared with 19.2 per cent in March.

UK inflation is now about double the equivalent US rate and significantly above that of the eurozone.

Wednesday’s figures will add to the difficulties facing BoE governor Andrew Bailey who admitted the day before that the central bank’s economic model had not been accurate and there were “very big lessons to learn” on the management of high price rises.

While the headline rate of inflation is likely to decline further as gas and electricity prices fall this year, the jump in the core inflation rate — which excludes food and energy costs — suggests there is more underlying inflationary pressure than hoped.

Paul Dales, chief UK economist at Capital Economics, said that although the drop in the headline rate was welcome, “much more important was the worrying large rebound in core inflation”.

He said this suggested that “the recent resilience of economic activity appears to be stoking domestic inflationary pressure”.

The BoE has said that it would raise interest rates again if inflation appeared to be persisting.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said Wednesday’s figures greatly exceeded expectations and were likely to prompt the central bank’s Monetary Policy Committee to act again. There was “too small a drop [in inflation] for the MPC to stop hiking in June”, he said.

The ONS said the main rate dropped because of more stable energy prices — but this was largely offset by substantial increases in the prices of second-hand cars and cigarettes.

Kitty Ussher, chief economist of the Institute of Directors, said that while the figures were concerning, there was still a chance that the fall in the headline inflation rate would change sentiment among companies setting prices and wages.

“Policymakers will hope that now that the headline rate is back to single digits, expectations of future inflation will now start to fall as well, which then could become self-fulfilling,” she said.

In the month of April alone, UK prices rose 1.2 per cent at a time when gas and electricity bills were frozen.

There was an 8 per cent rise in the communications component of inflation as mobile phone companies increased charges, moves often linked to the inflation rate.

There was another 1.4 per cent increase in food prices, the same rise in rents and package holidays over the month and a 6 per cent rise in postal costs.

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