The FTSE 100 suffered its worst day since August as a surprise jump in inflation raised fears the Bank of England will be forced to keep interest rates higher for longer.
Around £30bn was wiped off the value of the blue-chip index on Wednesday, as it closed almost 1.5pc lower at 7,446.
Housebuilders were among the biggest fallers on the FTSE 100 as rising prices dampened hopes of interest rate cuts.
Inflation rose to 4pc in December, according to the Office for National Statistics (ONS), up from 3.9pc in November after economists had predicted another fall. Core inflation held steady at 5.1pc in the month.
Traders subsequently pared back their rate expectations, with markets now pricing in the first cut to occur in May or June, compared with previous predictions this would happen as soon as March. The Bank of England held rates at 5.25pc, a 15-year high, for the third month in a row in December.
Rishi Sunak has made halving inflation one of his top pledges for 2023, a promise which was ultimately met after falling from its peak of 11.1pc in October 2022 as the energy crisis subsided.
But prices are still rising at double the rate of the Bank of England’s 2pc target, which is set by the Government.
Melissa Davies, chief economist at Redburn Atlantic, said: “It is far from clear that the Bank of England’s job is sufficiently done to allow a swift series of rate cuts, as expected by the market.
“In fact, there are a number of reasons the Bank should hold the line on rates into the second half of the year and then proceed slowly with cuts. Wage inflation remains elevated, services inflation is high and sticky, while goods inflation is poised to bounce in the face of renewed supply chain pressures.”
Much of the latest increase in inflation followed a jump in tobacco duty announced by the Chancellor, Jeremy Hunt, at the Autumn Statement and implemented almost immediately.
As a result the average packet of 20 cigarettes cost £13.30 in November, the ONS found, up 17pc from £11.37 a year earlier.
A standard pack of hand rolling tobacco hit £22.07, up almost one-quarter from £17.84 in November 2022.
Grant Fitzner, chief economist at the ONS, told Radio 4’s Today Programme that while inflation has fallen a long way from its peak, the final stretch to get it back to the Bank of England’s 2pc target “may take a little while”.
He said: “The big falls have been driven by falls in energy prices and goods prices, and a lot of those have been reflected in the inflation rate we see today.
“To get down from 4pc to 2pc you really need to see a reduction in what we call core inflation, so that strips out some of those volatile items like food, energy, alcohol and tobacco, and I think you would also need to see further falls in services inflation, which tends to be somewhat more sticky than goods price inflation.”
Responding to the latest inflation figures, Jeremy Hunt, the Chancellor, said: “As we have seen in the US, France and Germany, inflation does not fall in a straight line, but our plan is working and we should stick to it.
“We took difficult decisions to control borrowing and are now turning a corner, so we need to stay the course we have set out, including boosting growth with more competitive tax levels.”
Christine Lagarde, president of the European Central Bank, blamed market bets on aggressive rate cuts for holding up policymakers’ efforts to tame inflation
Speaking to Bloomberg in Davos on Wednesday, she said: “It is not helping our fight against inflation, if the anticipation is such that they are way too high compared with what’s likely to happen.”
Forecasts for future interest rates are important for central banks’ attempts to bring down inflation because they impact borrowing costs set by commercial lenders.
Markets’ tendency to ignore central banks’ messaging by predicting imminent rate cuts can also undermine credibility.
Mr Hunt is also in Davos this week after the Prime Minister shunned the annual World Economic Forum for the second year in a row.
Read the latest updates below.
