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US inflation rose to 2.9 percent in December, in line with expectations, prompting investors to increase bets on tax cuts this year.
Wednesday's data from the Bureau of Labor Statistics matched the forecast of economists polled by Reuters and was above November's figure of 2.7 percent.
Core inflation, which excludes food and energy prices, was 3.2 percent in December compared with 3.3 percent in November.
US stock futures and government bonds rallied sharply while the dollar fell after the release of the latest inflation data. Contracts tracking the S&P 500 equity gauge added 1.5 percent, while those tracking the tech-heavy Nasdaq 100 rose 1.8 percent.
In the government bond markets, the two-year Treasury yield that is sensitive to policy fell by 0.08 percentage points to 4.29 percent, while the 10-year yield – a benchmark for global borrowing costs – fell 0.09 percentage points to 4.7 percent. Yields fall as prices rise
The dollar's benchmark against six other currencies fell by 0.5 percent.
Fed officials have indicated that they plan to take a “careful approach” to reducing rates amid growing concerns that inflation may not fall quickly to the 2 percent target.
Investors are now betting that the Fed will cut rates in July – compared to September before the data was published.
Futures markets now imply a 60 percent chance of a second cut this year, up from 20 percent earlier Wednesday.
Most investors and analysts believe that the Fed will not cut rates again at its next policy meeting later this month. US central bankers have indicated in their forecasts that they will cut the tax rate by 50 basis points this year.
President-elect Donald Trump, who takes office on Monday, has laid out aggressive plans to impose tariffs on a large swath of imports, implement a major crackdown on undocumented immigrants and impose tax cuts.
Economists have warned that such plans could further increase inflation.