UK inflation cools in December, GBP/USD attempts to bounce back

UK inflation was cooler than expected in December, potentially lifting some of the risks to the UK economy. Headline CPI dropped to 2.5% in the year to December, with a monthly rise of 0.3%, lower than the 0.4% expected. However, the most notable change was in core inflation, which dropped to 3.2% from 3.5% in November.

That said, inflation remains above the 2% target set by the Bank of England (BOE) and is expected to rise again towards the end of the year. The risks of stagflation, which combine stagnant growth and persistent inflation, have weighed on UK assets these past few weeks, raising borrowing costs and threatening the government’s budget plans. The softer CPI data will have helped ease some of these concerns, but the relief seems limited. The yield on 10-year gilts has dropped to 4.8% but seems to lack the drive to drop much further. We may have to wait until the latest GDP data on Thursday for some extra relief trading, if so. For now, the odds of a 25 bps cut from the BOE next month have increased to 82% from 67% prior to the CPI data.

UK 10-year yield daily chart

Past performance is not a reliable indicator of future results.

Meanwhile, the momentum in the pound has turned positive, with GBP/USD reversing some of the recent weakness. The pair is attempting for a third day to return back above 1.22 but is struggling to find the support to sustain the momentum throughout the sessions. The softer CPI improves the outlook for the UK but there is still a more favourable economic landscape in the US, keeping the dollar supported.

GBP/USD daily chart

Past performance is not a reliable indicator of future results.