The latest data released by the Office for National Statistics shows that UK inflation has slowed down unexpectedly. This development is seen as supporting the argument for the Bank of England to lower interest rates once again in May. The decrease in inflation figures, with consumer prices rising by 2.8% in February compared to the previous month's 3%, was primarily driven by a decrease in clothing prices. Goods price inflation also showed a decline.

This news led traders to increase their bets on a potential interest rate cut, with the likelihood of a reduction in May now standing at 72%. As a result, UK bond yields dropped, particularly for short-dated gilts that are most affected by monetary policy, falling by approximately 8 basis points to 4.22%. Concurrently, the pound depreciated by about 0.5% to $1.2886.

The drop in inflation figures precedes Chancellor of the Exchequer Rachel Reeves' upcoming economic statement. The Chancellor is expected to announce significant government spending cuts to reestablish financial stability and revise growth forecasts. Reeves maintains that adhering to her fiscal rules, including financing day-to-day spending through taxation, has created the necessary stability for the Bank of England to lower interest rates and reduce mortgage costs for many British citizens.

In response to the inflation data, Luke Bartholomew, deputy chief economist at Aberdeen, noted that the Bank of England and the Chancellor would likely find some relief in the reduced inflation rate. Lower inflation is anticipated to alleviate the pressure on gilt yields, which have been a major concern for the Chancellor.

Following market concerns over government borrowing requirements after Reeves' October budget, which led to a rise in bond yields, ongoing worries prompted another spike in funding costs in January. This situation eroded Reeves’ fiscal flexibility and contributed to the anticipation of significant spending cuts in the Chancellor's forthcoming statement. Additionally, the government will unveil its bond issuance plans for the fiscal year 2025-2026.

Chief Secretary to the Treasury Darren Jones emphasized the government's commitment to stimulating economic growth to enhance living standards by safeguarding workers' income from tax increases.