Market Review 27th October 2025

Everything you need to know, Simplified!

Summary

• UK inflation undershot expectations, sparking a rally in gilts (UK government bonds) and small and mid-cap equities as markets priced in an increased probability of Bank of England (BoE) rate cuts

• Gilts have performed well in the last few weeks, with the 10-year yield falling from 4.75% on 9 October to 4.43% today

• US inflation also came in lower than expected, boosting expectations on near-term Federal Reserve (Fed) rate cuts despite a solid economy

• US labour market data remains ambiguous amid the federal government shutdown, but markets are leaning heavily towards a more dovish Fed (meaning more in favour of lower interest rates)

• In the week ahead: the Fed is expected to cut rates by 25 basis points (bps), while the European Central Bank (ECB) holds steady, keeping ‘dry powder’, or excess capital, in reserve.

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Market Review

UK gets a disinflationary boost

Better-than-expected economic data boosted UK assets. UK small and mid-cap equities rose 3.2% last week while UK bonds also rose as the 10-year gilt yield dropped 10bps to 4.43% (prices rise when yields fall). UK gilts have performed strongly over the last couple of weeks, with the 10-year yield falling from 4.75% since 9 October.

September’s inflation data released on Wednesday was the main boost for markets as monthly price growth came in flat, slowing from 0.3% in August. UK inflation came in lower than expected across the board, prompting markets to raise expectations for BoE rate cuts. The market quickly priced a 70% probability of a rate cut by December, up from 40%.

At 3.8%, annual inflation remains well above target, but economists - including those at the BoE - believe September marked the peak for UK inflation this cycle, with a more consistent downward trajectory ahead: down to 3.4% by year-end and around 2.5% by the end of 2026, with a sharper slowdown starting in spring next year.

With inflation now on track to fall further, thanks to cooling demand in the services sector, the risks of another inflationary flare-up in the short to medium term is fading. That said, it’s not off the table, especially if energy prices rise.

UK equities responded to this brighter economic outlook. Domestically focused small and mid-caps led the way, supported by cheaper valuations, easing inflation and the hopes of interest rate cuts. Cyclical sectors outperformed, with energy leading the way thanks to a sharp rise in oil prices (oil remains -11.4% lower on the year after rising 7.6% last week). The mood was further lifted by a surprise jump in retail sales, giving investors more confidence in the outlook.

The UK’s fiscal outlook remains a challenge, acting as both a drag on growth and a force keeping inflation in check. The government’s current approach - raising taxes without tackling long-term spending pressures - is dampening economic momentum and work incentives, which in turn helps ease inflation. Some economists argue the UK may be on the wrong side of the ‘Laffer curve’, where higher taxes start to reduce overall tax revenue. Even US economist Arthur Laffer himself commented last week on SpectatorTV that the UK is “taxing itself to death.” With the Autumn Budget just weeks away, fiscal policy will be a key driver for UK bond markets in the near term.

US gets a smaller disinflationary boost

With much of Washington still paralysed by the ongoing federal government shutdown, the flow of official data has slowed to a trickle. Still, last week’s delayed September inflation report offered some good news: headline CPI rose 3.0% year-on-year, slightly below expectations, while the more persistent services component showed welcome signs of disinflation. The release sparked a rally in equities and a drop in Treasury yields on Friday.

The Fed, which meets next week, is now widely expected to cut rates, with another reduction likely in December. Inflation remains above target but no longer uncomfortably so and the labour market, while cooling, continues to look healthy. Job creation has slowed but so too has labour supply, while the quit rate - effectively a measure of job market turnover and worker confidence - has normalised.

Rate cuts are likely to support equities, but there’s a risk they could also push longer-term bond yields higher if inflation worries return. US interest rates have dropped sharply in recent months, but there’s still uncertainty about where inflation is heading - especially if the Fed cuts rates quickly under political pressure.

There is plenty of optimism priced into the US Treasury market which now expects near enough five rate cuts by the end of next year. There is a risk that such easing while the economy remains so strong could result in returning inflation, particularly if trade tensions escalate. 

Economist Ed Yardeni recently described the current US backdrop as a kind of ‘Nirvana’ - with inflation near 3% and unemployment around 4%. He warns, though, that more rate cuts could end up inflating asset prices rather than helping the real economy, especially since growth and company earnings remain strong. In his view, the so-called ‘Fed put’ - the idea that the Fed will step in to support markets - may be back, but it might not be needed right now.

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The week ahead

Wednesday: Fed rate decision

Our thoughts: The Fed is widely expected to cut rates by 25bps at this week’s meeting, following through on its September guidance. Chair Jerome Powell is likely to frame the move as insurance against downside risks to employment, with alternative data showing a further slowdown in hiring. However, with official data delayed by the federal government shutdown and given the sharp drop in labour supply, the evidence of labour market weakness remains murky. Markets will also watch for signals on the timing of an end to quantitative tightening, which could come as soon as November, adding a further easing effect to financial conditions.

Thursday: ECB rate decision

Our thoughts: The ECB is expected to keep rates the same this week, maintaining its ‘Goldilocks’ view that recent weakness is temporary and largely driven by US tariffs. Policymakers see growth recovering into 2026 and inflation gradually returning toward target, with fiscal support in Germany providing the offset. With rates already viewed as near neutral, the ECB still has ‘dry powder’ should conditions deteriorate, but for now, no further easing is on the table.

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