UK inflation unexpectedly held steady in September, as expectations of a rate cut increased, pushing the two-year UK bond yields to a 14-month low.

Surprisingly, UK inflation remained stable in September, providing support for further interest rate cuts by the Bank of England. Data released on Wednesday showed that UK CPI rose by 3.8% year-on-year in September, unchanged from the previous month and below market expectations of 4%; while core CPI rose by 3.5% year-on-year in September, lower than the previous 3.6% and market expectations of 3.7%. Due to stable inflation, traders have increased their bets on interest rate cuts by the Bank of England. The money markets currently expect the Bank of England to cut interest rates by 17 basis points by the end of December, with a 70% likelihood of a 25 basis point cut. Before the release of the UK CPI data for September, the money markets believed that there was a slightly higher than one-third chance of an interest rate cut by the Bank of England by the end of December. As expectations for interest rate cuts heat up, the two-year UK government bond yield, sensitive to monetary policy, fell by 10 basis points at one point to 3.75%, the lowest level since August 2024. Boosted by the rise in two-year UK government bonds, yields on other term UK government bonds have also risen. In addition, the GBP/USD exchange rate fell by 0.4% to 1.3320. Evelyne Gomez-Liechti, strategist at MUFG, said: "These data may have come too late to trigger an interest rate cut in November, but we still believe that there is a high possibility of a 'risk management style interest rate cut' before the end of the year." It is worth noting that besides stable inflation, weak labor market conditions are another important factor supporting market expectations of an interest rate cut by the Bank of England. Data released last week showed that the UK unemployment rate rose to 4.8% in August, the highest level since May 2021, while economists had expected it to remain unchanged. In the three months to August, the pace of wage growth in the UK private sector slowed to 4.4%, a figure that not only fell below market expectations but also hit the lowest level since the end of 2021 - although this figure is still well above the level of around 3% that the Bank of England considers to be in line with the 2% inflation target. Bank of England Governor Bailey also pointed out last week that the UK economy is operating "below potential levels" and expressed concerns about the persistently weak labor market. Although Bailey acknowledged that high inflation remains a threat, he also noted that economic weakness could dampen future price increases.