Britain’s borrowing costs fell at the fastest pace in Europe on Wednesday after inflation unexpectedly held steady at 2.8pc.

The yield on 10-year UK government bonds, a benchmark for what the Treasury pays to borrow money, dropped from 4.79pc to 4.74pc, a two-month low.

The fall was more than twice as big as in France, Germany and Italy. While a 0.05 percentage point drop is small, even minor changes in yields can have significant impacts on public finances given the near £3tn size of Britain’s national debt.

The drop in borrowing costs came after official figures showed inflation remained at 2.8pc in May. Analysts had been expecting it to rise to 3pc.

The ONS said rising airfares, vehicle taxes and petrol costs were offset by cheaper food and heating oil.

Motor fuel prices surged by 24.6pc, which was the steepest jump since September 2022, but food prices rose at the slowest pace since December 2024.

The figures make interest rate increases less likely. Traders reduced bets on the Bank of England raising rates late this year, although they still favour one rise by December. At one stage during the conflict, as many as four rate rises were expected this year.

Martin Beck, chief economist at WPI Strategy, said the Bank of England was “all but certain” to keep interest rates on hold at its next meeting on Thursday. 

The inflation surprise has even raised the prospect of future cuts, he added, after oil prices fell below $80 for the first time since March after Donald Trump announced a deal to end the Iran war.

Mr Beck said: “Unless there’s a resumption of troubles in the Middle East, the worst fears about the inflationary fallout from the Iran conflict appear to have been avoided. Inflation should fall back quickly next year.”

The drop in borrowing costs comes a day before the Makerfield by-election, where Andy Burnham is the bookies’ favourite to win.

Mr Burnham, who is expected to challenge Sir Keir Starmer as prime minister, last year triggered a rise in borrowing costs after he said Labour must “get beyond this thing of being in hock to the bond markets”.

Jordan Rochester, an analyst at Mizuho Bank, said he does not expect an initial reaction from bond traders in the event of a Burnham victory. However, this would change over time if he seeks to loosen the fiscal rules.

He added that bond traders were hesitant to rule out the Bank of England raising interest rates after the latest inflation figures, but this would change in the coming months.

He said: “We think that the Bank of England may prefer to err on the side of caution as they walk through coming data but the market starts rethinking hikes priced further out.”