The British government's borrowing costs fell sharply as domestic and U.S. inflation unexpectedly fell, increasing bets that the central bank will cut interest rates in coming months.

Yields, or interest rates, on key UK government debt fell below 4.8%, retreating after surging to a 16-year high last week.

The moves follow new data showing Inflation fell to 2.5% in December from 2.6% the previous month.

It takes pressure off Chancellor Rachel Reeves, whose budget policies have been criticized for exacerbating market turmoil.

UK bond yields surged last week to highest levels since 2008 It comes as worries mount about Britain's economic outlook and rising borrowing costs.

The yield on 10-year government bonds has been close to 4.9%, reflecting investor unease.

But government data on Wednesday showed inflation fell for the first time in three months, appearing to help stabilize markets to some extent.

Analysts said slower inflation would give the Bank of England more leeway to consider further interest rate cuts to support the economy.

Investors on Wednesday ramped up bets on the possibility of a rate cut next month and backed a second rate cut before the end of the year.

Inflation news from the United States also supported bets on lower borrowing costs, with U.S. data showing the underlying pace of price increases was slowing.

The Labor Department's monthly report showed that overall inflation rose to 2.9% in December from 2.7%.

But markets are focusing on so-called core inflation, which excludes volatile food and energy costs and is seen as a better indicator of trends.

The gauge unexpectedly fell to 3.2% from 3.3%, raising hopes that the Federal Reserve will cut interest rates in the coming months.

U.S. stock prices rose and yields fell, a move that quickly rippled through global bond markets, where borrowing costs are rising due to U.S. economic dynamics.

Alongside the UK, Germany is among the countries where government debt yields have fallen.

However, Susannah Streeter, head of currencies and markets at Hargreaves Lansdown, warned that despite some relief today, UK borrowing costs remain high.

"Government borrowing costs have started to fall slightly, with 10-year gilt yields lower but still above 4.8%, a multi-decade high, as investors assess the UK's debt burden," she said.