Bond Watch: what 1.7% inflation means for bonds

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.      

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.           

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Inflation keeps falling

Inflation came in lower than expected for the year to September, at 1.7%, easing pressure on the Bank of England and opening the door to more aggressive interest rate cuts. Economists thought inflation would be 1.9%.

Core inflation, which strips out volatile items like food and energy, came in at 3.2%, below the 3.4% expected.

This report was welcomed by financial markets, with stocks and bonds rising in value.

Michael Browne, chief investment officer at fund manager Martin Currie, said: “The components of this fall are bullish: falling transport and household costs, only partially offset by rising hotels and restaurant costs. So, inflation is now pretty much confined to the travel and leisure sector, which is well past its summer peak.

“Expect a fall in these costs in the coming few months. We can see from the mixed outlooks from the companies in this sector, particularly the low-cost airlines, that demand is weaker than expected.”

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The good news means that investors now expect 0.75 percentage points of cuts to come in 2024, more than the 0.5 points of cuts expected before this data release.

That would take interest rates to 4.25% by the end of the year. The anticipated moves in interest rates are reflected in bond prices, with yields moving lower this week to reflect more aggressive interest rate cuts.

UK gilts maturing in under 10 years yield around 4% now, compared with about 4.2% before the drop in inflation.

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Deutsche Bank says the slowdown in activity, wage growth, and inflation will all but cement a November quarter-point rate cut.

The German bank says that this week’s inflation figure would be “music” to the Bank of England’s ears and could lead to a dovish pivot come November.

But it notes there are risks to rosy inflation projections and the idea that inflation is beaten.

Deutsche Bank says potential increases in various duties that may fuel inflation could be part of the 30 October Autumn Budget - such as on fuel, alcohol and tobacco - and there’s also plenty of uncertainty surrounding the scale and treatment of VAT on private school fees come January 2025. Moreover, a new National Living Wage is yet to be announced, it adds.