Sterling steadied during the session after UK inflation data came in weaker than market expectations in April, reducing the chances of the Bank of England adopting a more aggressive path of interest rate hikes and limiting any recovery attempt by the currency against a dollar that still holds clear momentum.
GBP/USD traded near 1.3403, with a slight gain of no more than 0.06%, while the price remained close to the lower end of the session range between 1.3375 and 1.3422. Meanwhile, the dollar stayed firm against major currencies, while EUR/USD slipped marginally to 1.1603.
Data from the Office for National Statistics showed that annual UK inflation fell to 2.8% in April, compared with 3.3% in March, and came below the market consensus of 3%. The decline was mainly driven by the impact of the energy price cap that came into effect at the beginning of April, along with smaller than expected increases in water, sewage and road tax bills.
Food prices and package holidays also helped ease inflationary pressure, while the statistics office noted that the decline largely reflected lower wholesale energy prices before tensions escalated in the Middle East, although higher petrol and diesel prices, along with some clothing and footwear items, limited the pace of the slowdown.
ING analysts believe that the weaker inflation reading, following disappointing labor market data, makes the case for aggressive Bank of England tightening less convincing. The June rate decision has become closer to a balanced scenario, with only a slight preference for a hike, while the bank reduced its bearish view on the euro against sterling due to continued political uncertainty.
Despite the latest slowdown in inflation, Francesco Pesole noted that this effect may be temporary, with expectations that UK inflation could approach 4% later this year if the impact of the Iran war and higher oil prices feeds into energy and goods costs inside the British economy.
Financial markets reacted to these developments by lowering expectations for monetary tightening, with traders now pricing in just over 50 basis points of rate increases by December, compared with around 60 basis points in the previous session. A July rate hike to 4% remains the most likely scenario, but market confidence in this path has clearly weakened.
On the political side, sterling remained under additional pressure as UK gilt yields rose sharply over the past two weeks, amid markets pricing in both potential Bank of England rate hikes and concerns over possible changes in political leadership. Investors fear that a government or leadership with a more expansionary spending approach could increase borrowing needs, adding another burden to the UK market.
Chancellor Rachel Reeves tried to calm investor concerns by announcing broad energy sector reforms that would give parliament wider powers to approve critical infrastructure projects, in an attempt to support confidence and improve the image of economic policy.
As for the dollar, it held near its highest levels in six weeks during today’s trading, supported by a more hawkish tone in the Federal Reserve minutes, which showed that a larger number of policymakers are open to raising interest rates if inflation remains above target. This direction added pressure on Asian currencies, especially the Australian dollar after weak employment data, while the Japanese yen held steady, supported by strong trade data and activity indicators.
The dollar remained the main source of pressure on sterling, supported by higher US Treasury yields and continued safe haven demand linked to the Iran conflict. This mix kept GBP/USD close to its lowest levels in nearly six weeks at 1.3304, with no strong catalysts allowing sterling to regain clear momentum in the near term.
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