The recent five-day rally in the Pound Sterling (GBP) seems to be losing momentum as investors adjust their strategies following a pause in the surge of United Kingdom (UK) gilt yields. This rally, initially driven by rising yields on UK government bonds, now faces new challenges as market participants turn their attention to upcoming US Consumer Price Index (CPI) data. The data is expected to play a crucial role in determining market trends and influencing central bank policies.
The UK inflation landscape recently saw a slight reprieve, with the annual headline inflation rate decelerating to 2.5% from 2.6% in November. This unexpected cooldown in inflation sparked a rebound in the Pound Sterling, which had been under pressure due to persistent inflation concerns and an anticipated trade war with the United States. The Pound's recovery, however, was tempered by a lack of confidence in the UK economic outlook, prompting investors to offload government bonds.
The European Central Bank (ECB) is anticipated to respond to low Eurozone inflation by cutting interest rates at least three times this year. As a result, the Euro (EUR) broadly underperformed on Wednesday, aligning with ECB officials' comfort with market expectations for interest rate reductions. The subdued US Dollar also provided support for the GBP/EUR pair, mitigating the impact of dovish ECB commentary.
"It makes sense for interest rates to reach 2% by the summer" – François Villeroy de Galhau
Despite the ECB's stance, market participants have priced in a significant number of ECB interest rate cuts, reflecting ongoing concerns about Eurozone inflation. Conversely, there is an 84% chance that the Bank of England (BoE) will cut rates by 25 basis points (bps) on February 6, as markets anticipate a shift in monetary policy amid a challenging economic environment.
UK gilts experienced a notable shift following the soft UK CPI report, with 30-year yields falling from their more-than-26-year high of 5.47% to 5.38%. This decline reflects a recalibration of investor expectations amid changing economic data and central bank policies.
The UK CPI report also revealed that core inflation grew by 3.2%, slightly below estimates of 3.4% and down from the previous reading of 3.5%. These figures highlight the complexity of the current inflationary environment, as policymakers balance growth and stability concerns.
As attention turns to US CPI data, markets brace for potential volatility in American trading. The December US CPI figures are anticipated to inject significant fluctuations into financial markets, influencing investor sentiment and currency valuations.