Pound Sterling Stays Under Pressure On Inflation Slowdown

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Inflation dropped by enough in January to keep alive the prospect of a March rate cut.

The British pound to stay under pressure against the euro, dollar and other major currencies after the ONS said UK inflation fell to 3.0% year on year in January.

This was down from 3.4% in December and in line with the consensus expectation. The fall follows a -0.5% month on month reading in January, down sharply from the 0.4% increase of December.

Core inflation fell to 3.1% y/y from 3.2%, but this was slightly above the 3.0% consensus prediction. Services CPI - long a worry for the Bank of England fell to 4.4% from 4.5%, slightly edging the consensus expectation for 4.3%.

The data come a day after it was revealed by the ONS that wage increases slowed materially and unemployment rose in December, which should ensure further disinflation is in the pipeline. The surprisingly weak labour market statistics triggered a material fall in the pound on the day, and these soft inflation readings won't trigger a material rebound.

However, for the Bank of England, these data will be welcome as it means their forecasts for inflation to reach the 2.0% target look plausible and that further reductions in Bank Rate won't risk upsetting the disinflation process.

UK bonds were bid following Tuesday's labour market statistics, and they should remain bid today. This will lower UK bond yields, a welcome development for Chancellor Rachel Reeves.

For the pound, the developments are a headwind as falling bond yields tend to weigh. Currency traders factor reduced international demand for lower-yielding UK bonds by selling the pound in the present.

The pound to euro exchange rate fell to its lowest level of 2026 on Tuesday at 1.1435, but is slightly off that level at 1.1449 in the wake of these inflation data.

The pound to dollar exchange rate fell as low as 1.35 on Tuesday but has since recovered to 1.3560.

Both pairs have come under pressure in February and are in short-term downtrends, and the repricing towards further UK interest rate reductions will underpin that move.

"Inflation is set to fall rapidly in the coming months, stabilising costs for households and supporting real household incomes. This, alongside further falls in interest rates, may finally shift households into spending, giving the economy some much needed support," says Anna Leach, Chief Economist at the Institute of Directors.

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