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A broad-based upside surprise in core inflation pulls the Fed's next hike forward and knocks the pound back towards its 2026 lows.
The Pound to Dollar exchange rate fell half a cent in minutes after U.S. core inflation came in hotter than expected for September, strengthening the case for a Federal Reserve rate hike at the end of this month.
Core inflation, which strips out food and energy, rose 0.3% on the month against a consensus of 0.2%, lifting the annual rate to 2.6% from 2.4%, according to the Bureau of Labor Statistics.
Headline inflation rose 0.6% on the month, as expected, with gasoline accounting for more than half of the increase, and the annual rate climbed to 3.7% from 3.4%.
The pound fell from 1.3270 to a low of 1.3212 on the release and trades at 1.3214 at the time of writing.
The data matters because the market had moved an October hike off the table after September's soft payrolls report, leaving December as the consensus date for the Fed's next move.
A core print that beats expectations across goods and services tells the Fed the inflation problem is broader than energy, which removes the case for waiting.
"With core CPI firmer than expected and the upside surprise was somewhat broad-based, we think that will convince most FOMC to deliver another rate hike at the end of the month," says Helen Lao, Economist at CIBC Capital Markets.
Lao notes both core goods and core services accelerated, with shelter rising 0.4% on the month and hotels, recreation, transport and medical services all firming.
Federal Reserve Hike Bets Heat Up
"Traders are sharply raising odds on an October rate hike, Treasury yields are edging up across the policy-sensitive end of the curve, and the dollar is advancing against its major rivals," says Karl Schamotta, Chief Market Strategist at Corpay.
Schamotta suspects the knee-jerk reaction could fade somewhat, but says the monetary tightening calculus has shifted.
Fed Chair Kevin Warsh said at Jackson Hole that the Fed would need to be confident underlying inflation is moving to target "clearly and at sufficient speed" before shifting to neutral, and Schamotta says September's figures push that confidence further out of reach.
"Markets are right to assume that policy will need to become much more restrictive to return inflation to target. The question is whether the Fed is prepared to tighten as much as the inflation outlook demands," says George Brown, Senior Economist at Schroders.
New York Fed President John Williams said on Tuesday the Fed may need to raise rates once more this year but expects inflation pressures to subside in 2027.
"It is not inconceivable that ten-year treasury yields continue to march higher," says Richard Carter, Head of Fixed Interest Research at Quilter Cheviot, who sees the current level of inflation persisting well into 2027 while the Middle East conflict holds oil prices up.
Pound Back Towards the Range Floor
The Dollar Index was already at a 2026 high before the data, with investment bank analysts seeing no catalyst to turn it lower, and this print will only fuel the USD's bullish thesis.
The Pound to Dollar rate has now rejected its 21-day moving average at 1.3263 for a second time this week.
Our Week Ahead forecast judged the pair vulnerable to further weakness with recoveries likely to stay shallow, and the daily chart confirms it.
The range floor at 1.3140, the 2026 low, is the next test, with a daily close above the 21-day average needed to change the picture.
Societe Generale expects speculative accounts to add to sterling shorts into the 28 October Budget, so the pound carries its own weight into that test.
A Fed hike on 28 October lands on Budget day, which puts both sides of the pair on the same date.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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