Inflation is tamed in the UK, as the FTSE pops up. The TPP midweek update.

UK inflation falls below the Bank of England’s target meaning more interest rates cuts are on the way.

UK inflation fell more than expected to a three-year low of 1.7 per cent in September, prompting the pound to fall and traders to increase bets on further rate cuts from the Bank of England this year.

Wednesday’s data release by the Office for National Statistics shows that inflation has come back under the BoE’s 2 per cent target for the first time since April 2021. The annual increase in consumer prices is less than the 1.9 per cent forecast in a Reuters survey of economists and compares with August’s figure of 2.2 per cent.

The retreat was driven by lower airfares and petrol prices. The numbers will come as a boost to Sir Keir Starmer’s government just two weeks before what promises to be a tough Budget containing steep tax rises. Chancellor Rachel Reeves is looking to somehow close a funding shortfall of £40bn and the rich are scared.

The numbers led investors to increase bets that the BoE would lower interest rates for a second time in its November meeting following its quarter-point reduction in August, and then make an additional cut in December. Traders had previously put the chance of two quarter-point rate cuts by the end of the year at roughly 50 per cent. That increased to 75 per cent after the inflation release.

This caused a small rally in the FTSE 100 and a drop in the pound as we would expect.

A November cut already looked “nailed on before today’s release”, said Paul Dales at Capital Economics. “The chances of that being immediately followed by another quarter-point cut at the following meeting in December has just gone up,” he added.

Aaron Hussein, global market strategist at JPMorgan Asset Management, said the inflation data and cooling wage growth showed the BoE was “gradually taming the inflation tiger”.

We would go one step further and suggest that it has already been tamed. The month-over-month figure for September was 0.0% meaning prices remained the same. 12 months ago, the September 2023 number was 0.5% therefore over the 12 months the annual figure dropped by 0.5%. Last month inflation was 0.3% which is above the target. However, what the Bank of England wants to see is a longer-term trend where inflation remains between 0.1% and 0.3% each month.

Here are the last 12 months' monthly inflation numbers including Wednesday 16^th October.

Month-over-month inflation

As a new month’s data is released, the previous year’s data for the same month falls off. This means inflation will most likely be stagnant for a couple of months, or it may increase a touch before increasing further in January. After January, it will likely drop sharply. Rather than focus too much on short term or long term trend, we look at the 3-month rolling average which currently shows an increase of only 0.1% where the target is 0.5%. This gives the Bank cause to drop rates at least 0.5% before the year end, possibly more.

Subsequently, the yield on two-year UK government bonds, which are sensitive to interest rate changes, fell 0.09 percentage points to 4.04 per cent. Governor Andrew Bailey said recently that rate-setters could be “a bit more aggressive” in lowering borrowing costs if inflation continued to fall. The comments were seen by investors as a signal that the BoE was poised to cut rates at both its November and December meetings.

Core inflation was 3.2 per cent, lower than economists’ expectations of 3.4 per cent, while the rate of services inflation fell from 5.6 per cent to 4.9 per cent, driven by lower airfare price rises. Services inflation is seen by the central bank as a key gauge of underlying price pressures. The 4.9 per cent reading was well below the 5.5 per cent forecast published by the BoE when it last released a full assessment of the economy in August. It chimes with separate ONS data this week showing that UK wage growth fell to 4.9 per cent in the three months to August, down from 5.1 per cent in the three months to July.

A key input into the BoE’s December meeting will be the shape of Reeves’s October 30 Budget and the impact of her attempts to get debt under control. Darren Jones, the chief secretary to the Treasury, said Wednesday’s inflation figures would be “welcome news for millions of families”, adding that “there is still more to do to protect working people”. However, the sharp drop in inflation will hit many lower-income families, given September’s 1.7 per cent figure is set be used to uprate working-age benefits next spring.

Stocks in the US fluctuated on the open after a selloff driven by some of the world’s largest chipmakers, with traders wading through a raft of corporate results.

The S&P 500 was little changed after dropping almost 1% on Tuesday. Nvidia added 1%, pacing gains in Megacaps. Morgan Stanley climbed 4% as traders and bankers joined the rest of their Wall Street rivals in posting better-than-expected revenue, fuelling a 32% profit jump for the third quarter. United Airlines Holdings rose 5% as earnings beat estimates.

“The stock market succumbed to some profit-taking off new highs, however, uptrends remain intact, so short-term pullbacks should be expected,” said Craig Johnson at Piper Sandler. “We view pullbacks within the current uptrend as buying opportunities.”

We would agree with this for now, but things can change very quickly especially when the buyers are retail investors.

China’s 200 million-strong army of retail investors was supposed to help the market turn a corner. Instead, it has become a source of weakness.

The country’s $9.7 trillion stock market experienced a rapid boom and bust starting late September, when central bank stimulus pushed the benchmark CSI 300 Index 25% higher in five days of trading. Many small investors who came late to the party were caught out when equities then slumped, and were forced to beat a hasty retreat.

“Close securities account” as a phrase cropped up 56 million times on social media platform WeChat on Oct. 9, as the benchmark index posted its worst performance since 2020. Money soon shifted back into savings from stock trading accounts, according to a bank index. Retail investors took to social media to lament their losses, with one user on Xiaohongshu saying “the stock market is really not suitable for a novice like me.”

The abrupt shift in sentiment has undermined hopes among bulls that China’s huge retail investor base, sitting on $21 trillion of deposits, will help drive a long term rally. Whipped by social media, small investors have instead proven fickle, turning a positive, the ability to quickly deploy capital to the stock market, into a negative, as they exacerbated price swings.

If the US has a similar change in sentiment then we could see bids disappear altogether, however, the one main difference is that the US economy is looking strong giving no cause for such pessimism………….yet.

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Have a great rest of the week, and good luck for your portfolio.

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