UK inflation gives UK stocks a shot in the arm

• European markets mixed, as eurozone indices fail to follow UK gains
• UK inflation slumps, with both headline and core CPI contracting in November
• Bank of England now deemed likely to enact up to six rate cuts next year

The FTSE 100 has enjoyed a welcome boost in early trade today, with markets reacting to a surprise slump in UK CPI that lifted expectations for a May rate cut from the Bank of England. The optimism seen in the UK has brought only moderate benefits for mainland European indices, with early upside being eradicated in part thanks to a concerning Ifo update that German companies continue to plan a fresh round of price hikes going forward. Red sea concerns remain evident despite the US pledge to assemble a cross-country naval force in the region. There remains plenty of questions around the speed, longevity, and effectiveness of such a coalition to ensure safety in the region, with supply chains set for widespread disruptions in the meanwhile.

The UK inflation report provided a shot in the arm for UK assets, with the FTSE 100 (0.8%) and wider FTSE 350 (+0.70%) gaining traction in early trade. While markets expected to see headline inflation continue its downward trajectory, the monthly contraction across both headline (-0.2%) and core (-0.3%) CPI figures caught markets off-guard to the benefit of stocks and the detriment of the pound. The -0.5% November CPI figure had provided us with a hint over the potential for something similar in the UK, speeding up the path back towards target.

Fortunately, the sharp decline in headline inflation has helped push expectations around the Bank of England’s easing activity next year, with markets now pricing a 75% chance of a rate cut in May (up from 55%). However, perhaps more importantly, markets are now weighing up a possible six rate cuts next year, with today’s data having taken that possibility from being an outlier (13.5%) to a likely outcome this time next year (49%). This puts the BoE on a similar pathway to their ECB and FOMC counterparts, with the bank expected to shift their focus onto the risk of overshooting their 2% target in the second quarter of next year.