LONDON, Sept 20 (Reuters) - Investors scrambled to reel in bets that the Bank of England will raise interest rates again on Thursday after weaker-than-expected inflation data suddenly made that prospect much less certain.
Gilt yields dropped and there was a sharp repricing of the futures curve after annual consumer price inflation slowed to 6.7% in August from 6.8% in July, against widespread expectations for an increase to 7%.
As of 0735 GMT, overnight index swaps pointed to a 45% chance that the BoE will keep interest rates on hold on Thursday - up from 20% on Tuesday.
The chances of further rate hikes that would take Bank Rate above 5.5% - priced as a certainty only a month ago - dwindled to around 20%, from above 40% on Tuesday.
The inflation data follows signs of a weaker economy and a drop in pay settlement data published earlier on Wednesday.
"The case that interest rate rises have now gone far enough is looking increasingly convincing and the (BoE) could present a decision to hold fire as 'wait-and-see' rather than a definitive end to rate rises," said Martin Beck, chief economist adviser to the EY ITEM Club consultancy.
Short-dated gilt yields, which are highly sensitive to interest rate expectations, slumped in early trade.
The yield on the 3.5% 2025 gilt - currently the two-year benchmark - sank 15 bps to 4.830%, its lowest level since June 6.
Longer-dated gilt yields also fell, but not by as much.
The spread between the 10-year benchmark bond yields of Britain and Germany narrowed sharply to a four-month low of 154 bps, from 160 bps on Tuesday. (Reporting by Andy Bruce)
