Pound Sterling and Dollar Today: UK and US Inflation Data Rocks Markets

January 16, 2025 - Written by David Woodsmith

STORY LINK Pound Sterling and Dollar Today: UK and US Inflation Data Rocks Markets

Both UK and US inflation data came in slightly cooler than expected.

However, the two reports had completely different effects.

The pound is higher on Wednesday, while the US dollar is lower.

Key inflation data was released in the UK and US on Wednesday. Both reports showed slightly lower than expected readings, and led to highly volatile moves.

Lower UK Inflation Has an Unusual Effect

Currencies usually go up when inflation rises. Higher inflation tends to lead to higher rates and a more hawkish central bank policy. However, the pound has been moving inversely to yields in recent weeks as they have reached extreme levels where they are problematic to the economy and to government borrowing, The fear in the UK is that the government will either have to shelve spending plans or raise taxes to cover its budget. Neither option is friendly to sterling exchange rates.

This backdrop led to a rather unusual reaction to Wednesday’s inflation release. The data showed a slower-than-expected increase of 2.5%, while core measures of 3.2% were lower than the 3.4% feared by analysts. This kind of “miss” often leads to a move lower in a related currency but the pound moved higher in early trading as yields moved down from extreme levels not seen for 25 years. GBPUSD gained around 0.5%, while EURGBP dropped over 0.3% to 0.84.

The data helps pave the way for further BoE cuts this year. Services inflation is key and it moderated more than expected. YoY growth in the services sector eased to +4.4% - the lowest rate in nearly three years - and it marks a fall from an annual rate of +5% in November. For context, while goods inflation globally has marked a sharp retreat in recent years from pandemic-highs, services inflation has been much more stubborn and been a major hurdle to the BoE’s easing plans. The trend is now moving in the right direction and could give the Bank of England some welcome room for manoeuvre – they next announce their latest interest rate decision on Thursday 6 February.

US Inflation Ignites Major Volatility

Strong economic data, inflation moving in the wrong direction and a persistent march higher in yields has been the market’s main focus this year. Stocks have been under pressure and early this week had fallen back to their lowest level since the November election. Wednesday’s lower-than-expected inflation readings were therefore a welcome sight and ignited a significant recovery. The S&P500 is 1.8% higher and the Nasdaq has gained over 2.2%.

Unlike the UK and the reaction in the pound, the reaction in the US dollar is more logical. Lower yields have pulled the dollar down by around 0.4%. However, the data itself was far from ideal for the Federal Reserve. Headline CPI came in at 0.4%, as expected, leading to a YoY figure of 2.9%. The relief came from core CPI which has been stuck at an elevated rate of 0.3% for three months. It came in at 0.2%. Unrounded, the reading was a less impressive 0.225%, and considering the consensus estimate was 0.25% and rounded up to 0.3%, the “better-than-expected" description is not as good as it seems.

To conclude, the CPI data is enough to take the pressure off markets and the Fed. Following last week’s jobs report, some analysts were speculating the Fed may have to hike this year. That seems a step too far and the Fed may be able to pull off its projected two cuts. Indeed, ING still expects three:

“Market Federal Reserve interest rate cut expectations have moved modestly dovishly on this, pricing around 40bp of cuts this year, but 10Y Treasury yields are 10bp lower. We have been predicting three 25bp rate cuts for the year and are sticking to that view for now. However, it may be that rather than cutting in March as we had been suggesting the first move for 2025 is more likely to happen in June looking at the data right now. “

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TAGS: Pound Dollar Forecasts