By Amanda Cooper
LONDON (Reuters - British property stocks and government bond prices soared on Wednesday after data showed UK inflation slowed by a lot more than expected in June, which could offer cash-strapped consumers and businesses respite from many more punishing rate rises.
The pound fell by the most against the dollar so far this month at one point, but recovered some ground to trade within sight of last week's 15-month highs.
British annual consumer price inflation fell to a lower than expected 7.9% in June, below a forecast for a decline to 8.2%.
June's rate was a long way off last October's 41-year high of 11.1%, but far above the BoE's 2% target rate.
This did not deter investors from diving into British government bonds, which sent two-year gilt yields down by the most since March. Prices and yields move inversely to one another.
On the stock market, the FTSE 100 rose 1.2%, but gains in the blue-chip index were dwarfed by those in the mid-cap FTSE 250 - far more exposed to the British economy - which rose nearly 3%.
An index of shares in UK homebuilders that includes the likes of Barratt Developments (LON:BDEV) and Taylor Wimpey (LON:TW), shot up by as much as 7.2%, heading for its biggest one-day gain since late 2008.
"Some good news on UK inflation at last, coming in below expectations for June and most importantly the core inflation rate fell more than thought," Neil Birrell, who is chief investment officer at Premier Miton Investors, said.
"It is still high in absolute terms and the Bank of England needs to be vigilant and act accordingly until there can be a level of certainty that inflation is back under control."
Core inflation - which excludes food, energy, alcohol and tobacco prices - dropped to 6.9% from May's 7.1%. This was below forecasts for a decline to 7.1%, but not far from last month's 31-year high.
Sterling was last down 0.7% at $1.29485 and fell 0.7% against the euro to 86.74 pence, its weakest for nearly two months.
The UK still has the highest inflation of the G7. In the United States, headline consumer price pressures are running at a rate of just 3%, while euro zone inflation is at 5%.
Wholesale energy prices have fallen sharply this year, which has offered consumers and businesses some respite, but mortgage rates are rising fast and grocery inflation is still in double digits.
British finance minister Jeremy Hunt said there was still a long way to go to reduce inflation towards target.
Hunt told reporters on Wednesday that the government and Bank of England had taken difficult decisions on inflation in recent months: "We're seeing the first fruits of that, but there's a long way to go."
Two-year gilt yields were last down 20 basis points on the day at 4.843%, having dropped earlier by as much as 26 bps.
Meanwhile, interest-rate derivatives showed traders no longer believe UK rates will have to rise above 6% to temper inflation.
UK overnight swaps show traders expect a peak of 5.85% by February and the first real prospect of a rate cut by the middle of the year.
As recently as Monday, money markets showed traders were factoring in a peak of around 6.1% by next August.
"Today's fall in CPI inflation is a small step in the right direction for the UK economy, but high wage growth and stubborn underlying prices show there is still a long journey ahead to drag inflation back down into more stable territory," said Jeremy Batstone-Carr, European strategist at Raymond James.