Renewed inflation fears stalk central bankers as markets shudder

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Leading central banks have warned that inflation is proving stickier than expected and that they will only cut borrowing costs gradually in 2025, in a shift that hit bond markets on both sides of the Atlantic.

A day after Federal Reserve officials dialled back their rate-cutting expectations, the yield on US 10-year Treasuries, a bedrock of global finance, hit the highest since May at 4.59 per cent. The yield has jumped 0.2 percentage points in the past two days alone as investors rush to rethink their expectations for Fed policy over the next 12 months.

Long-term US Treasury yields, which move inversely to price, typically rise with interest rate and inflation expectations.

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UK yields also reached 4.66 per cent, the highest in more than a year as Bank of England officials on Thursday warned of an increased risk of “inflation persistence” and kept benchmark rates on hold.

Inflation has begun to pick up again in both the US and UK, while uncertainties over the policies of US president-elect Donald Trump are clouding economic prospects across the globe. 

Andrew Pease, chief investment strategist at Russell Investments, said investors were concerned that there would now be a “much slower pace of easing [in monetary policy] until inflation comes down”, describing “last-mile challenges” in central banks’ struggle to bring prices under control.

Concerns that stickier inflation will slow the pace of interest rate cuts have driven the sell-off in US and UK bond markets in recent weeks, coupled with worries that loose fiscal policy will make the problem worse.

US stocks also fell on Wednesday after the Fed trimmed interest rates but projected fewer rate reductions in 2025 than previously forecast. They recovered somewhat on Thursday.

The cautious language from the US and UK rate-setters contrasted with the message from the European Central Bank, which last week insisted the “darkest days” of inflation were over, leaving the way open to fresh rate cuts. 

Investors have been trimming their expectations for policy easing in recent weeks. Traders have priced in two quarter-point rate cuts for the BoE next year, from the four that were priced in in October. They have priced in one cut from the Fed next year, with a 50/50 chance of a second, whereas two cuts had been the expectation a month ago.

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Even as they lowered rates by a quarter point, Fed officials said they only expected to reduce rates by 0.5 percentage points next year, compared with a forecast three months earlier of 1 percentage point. The central bank’s caution was partly attributable to potentially inflationary policies from Trump, economists said, pointing to the prospect of tax cuts, higher tariffs and mass deportations. 

US inflation readings in September and October came in stronger than expected, adding to arguments for caution. Fed officials on Wednesday increased their estimates for inflation in 2025, reflecting those worries.  

The BoE held its key rate at 4.75 per cent on Thursday, with the majority of officials flagging higher inflation risks even as the bank projected zero growth in the final quarter of the year. 

Trade policy uncertainty had increased “materially”, the BoE said in a reference to Trump’s tariff plans, while stressing the impact on UK inflation would not be clear for some time. 

While three members of the nine-strong Monetary Policy Committee called for an immediate rate reduction, the majority favoured keeping rates unchanged given increased “risk of inflation persistence”. 

“With the heightened uncertainty in the economy, we can’t commit to when or by how much we will cut rates in the coming year,” Andrew Bailey, BoE governor, said in a statement.