British pound extends rise on sticky December UK inflation

UK CPI rises to 4% in December, hawkish repricing of interest rates supports sterling

The British pound saw a slight uptick on Thursday, building on gains from the previous day, as the annual consumer price inflation rate unexpectedly rose last month. The Consumer Price Index (CPI) increased to 4.0% year-on-year in December, up from November's more-than-two-year low of 3.9%.

The unexpected rise led to a boost in sterling and higher bond yields, as markets adjusted their expectations, anticipating that the Bank of England (BoE) might maintain higher interest rates for an extended period.

Having raised rates 14 times from the end of 2021 to August last year, the BoE had reached a 15-year high of 5.25%, responding to inflation reaching a more than four-decade high of 11.1% in late 2022.

Core inflation, excluding volatile components such as food and energy, remained at 5.1% in December – contrary to expectations of a fall to 4.9%. Services inflation increased to 6.4% in December from 6.3% in November.

In a Wednesday morning note cited by Reuters, analysts at Japanese investment bank MUFG wrote:

"The stronger than expected reading for both core and services inflation in December .. are disappointing and will discourage the BoE from beginning to cut rates sooner. The UK rate market is not fully pricing in the first 25bps rate cut from the BoE until June. The hawkish repricing of the UK rate curve has contributed to the pound strengthening modestly this morning [on January 17]”.

Kyle Chapman, FX markets analyst at Ballinger & Co, added:

"Sterling has fought back on the basis that December's CPI print proved to be stickier than expected”.

At 1200 GMT, the pound was marginally higher against the dollar at $1.2687, extending the 0.3% gain from Wednesday that halted a three-day decline against the greenback.

The euro to pound rate held around 85.82 pence, with the euro trading slightly stronger than sterling at the time of writing. The British pound gained 0.3% on the common currency the day before.

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Markets price out UK interest rate cuts in May following sticky CPI report

Markets swiftly adjusted their expectations after the inflation report, pricing out the possibility of interest rate cuts in the UK. Interest rate futures indicated less than a 50% chance that the BoE would loosen its policy at the May 9 meeting, compared to an approximately 80% chance late on Tuesday.

In an overview of the inflation report on Wednesday, Markets.com Chief Market Analyst Neil Wilson said the UK central bank would now be “extra cautious” in timing its rate cuts:

“[The] Bank of England [now] faces inflation ticking up…the dreaded wage price spiral is here. CPI rose to 4.0% Or is it just the Red Sea mess? Odds of a May cut have fallen from around 84% yesterday to 58% this morning after the print. This is bound to make the BoE extra cautious over timing its rate cuts. It could delay the first cut and slow down the pace of cuts this year – but it’s only one data print. Only one but nevertheless one that speaks to the non-linear disinflation we have anticipated”.

While several major central banks are anticipated to cut interest rates this year, the Federal Reserve is viewed as more likely than not to reduce borrowing costs in March, and the European Central Bank 9ECB) is expected to make a move in April.

Niels Christensen, chief analyst at Nordea, reviewed market sentiment in a comment to Reuters:

"In the U.S. and the euro zone you can see that inflation is coming down, but it's certainly less visible in Britain. The bottom line is that it's a difficult spot for the Bank of England and they will have to wait a little longer for data before seeing whether they can cut in June as the market expects”.

GBP forecast: ING says 1.26-1.28 looks like a “likely near-term" for GBP/USD

In a British pound forecast issued on Thursday, Chris Turner, Global Head of Markets at Dutch bank ING, wrote:

“Investors took about 20bp out of the 2024 Bank of England easing cycle yesterday. That move supported sterling across the board. [...] It looks like we will probably have to cut our EUR/GBP forecasts soon. Our current forecasts of a move up to 0.88 later this quarter and 0.90 later this year look too aggressive.

The inflation data also helped GBP/USD hold support at 1.2600 yesterday and 1.26-1.28 looks a likely near-term range until the broader dollar trend resolves itself”.

At the time of writing on January 18, the GBP to USD exchange rate held at $1.2685, while the EUR to GBP rate was mostly flat at 0.8585. The pound to dollar rate has risen by close to 2.5% over the past year.

The U.S. dollar index (DXY) – a measure of the greenback’s strength against six major currencies – traded 0.15% lower at 103.30.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.