Bond Watch: why higher inflation didn’t spook bond markets

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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Here’s what you need to know this week. 

UK inflation comes in higher than expected 

It was announced earlier this week that UK consumer price index (CPI) inflation for the year to December 2023 was 4%, above the 3.9% November reading. This is the first time the rate has increased since February 2023. 

The largest upward contribution to the monthly change in CPI annual rates came from alcohol and tobacco, while the largest downward contribution came from food and non-alcoholic beverages, according to the Office for National Statistics (ONS).  

Core CPI (excluding energy, food, alcohol and tobacco) rose by 5.1% in the 12 months to December 2023, the same rate as in November. 

Although above the forecast of 3.8%, bond and currency markets did not react much to the news.  

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Bond yields moved slightly higher on the news, with the 10-year gilt yield moving from 3.8% to 3.9%. 

Adam Darling, fixed income portfolio manager at Jupiter Asset Management, commented: “Today’s inflation miss highlights that the decline in inflation towards the Bank of England’s target won’t be a straight line. However, the underlying economic fundamentals in terms of a cooling job market, weak money supply and soft business and consumer confidence suggest that UK inflation should continue to fall and that the Bank should start cutting rates this year.” 

The rise of money market funds 

Data firm Morningstar revealed that money market funds were the only fund sector in the UK to record net inflows last year.  

Money market funds are a cash-like investment that can be held inside stocks and shares ISAs, SIPPs, or general investment accounts.  

They own a diversified basket of safe bonds that are due to mature soon, normally within a year, meaning that investors can earn an income on their cash with minimal risk.  

Investors use them to park cash balances, but also earn a modest income inside a tax-friendly wrapper. 

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The rise of money market funds, where yields are now above 5%, reflects higher interest rates and the extra options they provide investors.  

Popular strategies include Royal London Short Term Money Market, L&G Cash Trust, and Fidelity Cash. 

Meanwhile, Morningstar found that equity funds saw more than £25 billion redeemed in 2023 - almost £3.5 billion more than in 2022.