The UK's core CPI measure of inflation fell unexpectedly in December to 1.3% from 1.7% on a 12-month basis, its lowest level in three years, adding to the mounting pressure on the Bank of England to cut interest rates at this month’s Monetary Policy Committee (MPC) meeting.
The ONS' latest data also shows that the 12-month CPIH rate, which includes owner occupiers' housing costs, also fell to 1.4% from 1.5% in November, primarily as a result of a downward trend in the price of accommodation services and clothing.
CPIH was saved from a further fall due to minor uplifts in furniture and household goods, communications, and miscellaneous goods and services.
It follows figures published by the BoE on Monday (13 January), which revealed that November saw the UK grow at its weakest rate since 2012. The publication prompted outgoing Governor of the Bank Mark Carney and two MPC members signal that a rate cut could be imminent.
Chief market analyst at markets.com Neil Wilson said the weaker than expected inflation data offers "the necessary cover for the Bank of England to cut interest rates this month", and the latest "may persuade a couple more on the MPC to cut now, to get ahead of the curve and not allow softer data to fester".
Olivier Konzeoue, FX sales trader at Saxo Markets, agreed and placed a 62% probability of a 25bps rate cut, up from 50% yesterday.
He added that the growing likelihood of a rate cut is "putting further pressure on the ever resilient Great British pound."
Sterling was down 0.3% against the dollar in the wake of the data release, and down 0.2% against the euro and yen respectively.
Gilt yields also fell this morning as markets reacted to the inflation data. However, portfolio manager of the Man Dynamic Allocation fund Ben Funnell said he expects them to rise as a result of the conclusive result of December's General Election and the government's promise that "austerity is over".
Funnel added: "The Conservative manifesto effectively promise an additional £100bn of capital spending over the next five years, around 5% of GDP. Only £22bn of this has so far been allocated to specific projects.
"Our expectation is that the rest of this money will be spent in short order as Boris seeks to consolidate the many post-industrial ‘left behind' seats he won. In this scenario we don't think the government will have 10-year money at 66 basis points for too long."
Head of investment services at Close Brothers Asset Management Robert Alster blamed the weak inflation data on "a relatively mediocre Christmas trading period", which saw retail footfall drop by 2.5% throughout December.
However, he said that while the weak inflation data suggests there is "clear headroom" for a rate cut, the impact of "Brexit-linked uncertainty improving and wage growth outstripping inflation" could see CPI "creep closer" to the BoE's target of 2% and thereby make a rate cut "more unpalatable".
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