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Pound Sterling looks vulnerable to further declines after a well-behaved inflation print.
The pound looks set to remain under pressure against the euro in the near term after UK inflation met expectations, prompting some market participants to bet the Bank of England will cut interest rates again in November.
This 'dovish' recalibration took place after UK CPI inflation read at 3.8% year-on-year in August, which was as expected and was unchanged on July. Month-to-month, the figure was up to 0.3% from 0.1%, but this was as expected.
Core CPI actually slowed to 3.6% from 3.8%, again as expected. The all-important measure of inflation in the services sector - to which the Bank of England is particularly attuned - fell to 4.7% from 5.0% previously, which was below the consensus estimate.
So that's three on-consensus readings and one below, meaning there were no upside surprises that would have shifted the dial away from further rate cuts, which would have in turn supported Sterling on the day.
The pound to euro exchange rate dropped 0.5% on Tuesday to 1.15 and looks exposed to lower sub-1.15 levels in the coming days.
To be sure, GBP/EUR's recent slump is more a reflection of a notable bout of euro strength, as the single currency had a bumper day on Tuesday, rising against the pound, dollar and a host of other major currencies.
Elsewhere, Sterling is slightly softer against the U.S. Dollar, but it must be remembered GBP/USD is overwhelmingly a function of USD performance and tonight's Federal Reserve rate cut could keep the Greenback under pressure.
Regardless of what the euro and dollar are up to, if you wanted a stronger pound, you certainly needed today's inflation data to beat expectations and further reduce the likelihood of more rate cuts in 2025.
That undershoot in services inflation has left the door ajar to another cut in November, which should curb short-term UK bond yields and potentially weigh on the pound's upside potential against non-USD currencies.
Analysts at Société Générale say the Bank will cut interest rates faster than markets are currently expecting, and this should weigh on the pound against the euro.
"The UK faces a very sterling-unfriendly fiscal/monetary policy mix, with further fiscal tightening likely at November’s Budget and rate cuts set to follow. The Government feels the need to establish fiscal credibility but has struggled to control spending, making tax increases inevitable," says a note from the FX strategy team dated September 16.
"EUR/GBP is now moving in line with its short rates differential, and our new Global Economic Outlook expects the ECB to have completed 80–90% of its easing cycle, while the BoE has only completed 50–60%. The probability of a BoE cut in November is now close to 50–50, leaving room for near-term GBP downside," it adds.
However, further rate cuts could be a mistake, say economists who point out the UK's rate of inflation is nearly double the Bank of England's 2.0% target.
"The Bank of England is nearing the end of its rate-cutting cycle, but faces a delicate balancing act: wage growth is softening, yet household inflation expectations are edging up. Households perceive inflation at 4.8% - close to food price inflation at 5.1% and above private-sector pay growth. After years of painful volatility, the priority must be to squeeze inflation decisively out of the system," says Anna Leach, Chief Economist at the Institute of Directors.
Economists at HSBC say the Bank won't cut interest rates again until later in 2026. If this assessment is correct, then the pound should find support from the UK's high superior bond yields which will serve to attract foreign capital inflows.
"These are extremely high figures and leave the UK as a global outlier," says Kathleen Brooks, research director at XTB, commenting on the inflation outturn. "The bigger issue is that too many prices are rising, and not enough are falling. Food price inflation is another price increase we literally cannot get away from. There were increases in the price of vegetables, fish and cheese last month."
As Leach said, food prices have a significant influence on consumer perceptions of inflation, meaning the Bank will need to trade cautiously.
With the November policy decision a 50/50 flip, the clincher will certainly be next month's inflation release of the September inflation report. The Bank of England thinks inflation will peak in September, and any undershoot here would almost certainly prompt the Bank to reduce rates again.
However, upside surprises would hand the initiative to the 'hawks' and delay the next move until 2026.