GBP flows: GBP slightly weaker after softer CPI

UK CPI has come in below expectations, with the headline rate at 2.5% and the core at 3.2%, against market consensus of 2.6% and 3.4% respectively. CPIH inflation, which includes owner occupied housing costs (OOH), held steady at 3.5% due to OOH rising 8.0% y/y. GBP has weakened modestly on the data, which increases the chance that the BoE will cut rates at the February 6 MPC meeting. This is currently priced as around a 60% chance, but with inflation declining, and more clearly than the y/y rates suggest with underlying trends looking much more moderate in the last 6 months or so, we would rate the chances of a UK rate cut as higher than this.

EUR/GBP has risen in recent sessions even though UK yields have been rising. The rise in UK yields looks like an indication of a loss of confidence in the UK and concern about the UK fiscal situation rather than a real expression of the market’s expectation of monetary policy, as the UK data has been generally soft and the BoE comments on balance dovish. This sort of loss of confidence would normally affect the long end of the curve much more than the short end, and we would expect to see some curve steepening with the front end of the curve falling to reflect expectations of more BoE easing. So while GBP may not suffer further losses due to confidence effects, there is likely to be some yield decline to drive some further GBP losses.

While there has been much comment on the decline in GBP/USD to its lowest for a year, in reality GBP is at strong levels on a trade-weighted basis after a strong performance for most of 2024, with the weakness against the USD mainly a result of USD strength rather than GBP weakness. So some decline in GBP should not be something that the BoE is concerned about, and won’t prevent rate cuts. We look for EUR/GBP to head towards 0.85 by the time of the February 6 MPC meeting.