Pound Sterling vs. Euro and Dollar: Inflation Reaction

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Soft undertones in the UK’s monthly inflation report encouraged selling of pound sterling, but losses should be shallow.

The currency initially dropped across the board after it was reported UK CPI inflation declined to 3.6% year-on-year in October versus the 3.6% expected.

With inflation falling from September’s peak at 3.8%, markets are betting the Bank of England is well placed to lower interest rates in December.

The monthly figure was also on-target at 0.4% m/m. However, monthly core inflation was softer than anticipated at 0.3% m/m vs. 0.4% expected.

A softer monthly core reading was accompanied by some below-consensus producer price readings of 0% m/m for PPI output and -0.3% m/m for PPI input. This suggests price pressures earlier in the pipeline aren’t a threat.

The pound to euro exchange rate dropped to 1.1336 in the wake of the figures before recouping those losses to 1.1346.

The pound to dollar exchange rate eased to 1.3140 from 1.3150.

Sterling has fallen steadily over recent weeks as markets raised bets for further interest rate cuts at the Bank of England, with the next coming in December.

These inflation data suggest the disinflation process is resuming in the UK, verifying those market bets for rate cuts.

However, there are some ‘hawkish’ elements of the report to consider.

Notably, CPI services inflation, a major source of consternation for the Bank of England, was unchanged in September, at 4.7%.

For headline inflation to fall to 2.0% on a sustainable basis, the economy’s most dominant sector – services – must contribute. Until there are clear signs of disinflation here, the Bank of England will be limited in its scope to lower interest rates.

This stubborn underbelly to the UK’s inflation picture is why market pricing shows investors are only positioned for two further cuts from here, which would take Bank Rate to 3.5%.

If the repricing lower in expectations fades, then the pound can find itself better supported.

“CPI inflation down to 3.6% but it remains significantly above 2% target. CPI excluding energy is still at 3.7%, same as last month, so CPI decline due to energy, not an easing in other inflationary pressures,” says Andrew Sentance, an economist who has served on the Bank of England’s Monetary Policy Committee.