UK government bonds extended their winning streak to a fifth consecutive session as the steady May inflation reading alleviated pressure on the Bank of England to raise interest rates.

The yield on the UK 10-year gilt fell by 4 basis points to 4.75%, marking its lowest level in two months. Concurrently, traders increased bets that the central bank's policymakers will keep the benchmark interest rate at 3.75% on Thursday and implement just one more 25-basis-point hike before the year ends.

Jeremy Batstone-Carr, a European strategist at Raymond James Wealth Management, commented, "Today's data does not provide a compelling case for adjusting the base rate tomorrow."

Official figures showed the UK's headline Consumer Price Index (CPI) rose by 2.8% year-on-year in May, unchanged from April and below the 3% forecast by economists. This indicates that price pressures were weaker than anticipated even before a potential US-brokered deal to end the conflict in Iran, which could have caused energy costs to plummet.

However, a concerning detail was the rise in services inflation to 3.7%, which exceeded expectations.

Prior to the US-Israel attacks on Iran in late February that triggered a surge in oil prices, traders had been pricing in 50 basis points of rate cuts from the Bank of England this year. The subsequent closure of the Strait of Hormuz to most shipping disrupted those bets, leading markets to swiftly price in as many as four 25-basis-point hikes instead.

The UK gilt market had suffered a more severe sell-off compared to other G7 nations, partly due to the country's heavy reliance on imported energy and market fears that political instability could further undermine its already fragile fiscal outlook.

However, hopes for a peace deal that would lower oil prices, coupled with data showing the UK economy contracted in April for the first time in eight months, have gradually scaled back expectations for rate hikes.

Commenting on the May inflation data, Andrew Wishart, Senior UK Economist at Berenberg Bank, stated, "All of this should gradually steer the market towards our view that the Bank of England will not raise rates this year." He forecasts a 25-basis-point cut in December, followed by two more cuts of the same magnitude in the first half of next year.

Despite the recent rally, UK gilts may still face further volatility in the coming days. UK Prime Minister Keir Starmer is expected to face a leadership challenge soon, potentially from his former Health Secretary Wes Streeting or Manchester Mayor Andy Burnham, should Burnham win a by-election on Thursday.