Slowdown in UK inflation eases pressure on Bank of England

British inflation fell by more than expected in January and there were signs of cooling price pressure in parts of the economy watched closely by the Bank of England, adding to signs that further hefty interest rate hikes are unlikely.

Despite the fall, inflation remains higher than in the United States or euro zone, and many forecasters think it will stay higher as a result of Britain's acute labour shortages and other constraints on the economy such as Brexit.

British core CPI - which excludes energy, food, alcohol and tobacco - fell to 5.8% in January from December's 6.3%.

Sterling fell against the U.S. dollar and the euro after the data. British government bond prices rose sharply as investors ruled out the chance that the BoE will need to raise interest rates in March by another 0.5 percentage points. Most expect a quarter-of-a-percentage-point raise next month.

Earlier this month, the BoE said it saw signs that the surge in consumer prices had turned a corner and it suggested it was close to ending its run of interest rate hikes.

Prices of services, which are also in the BoE's spotlight, slowed their rise in January, increasing by an annual 6.0% compared with 6.8% in December.

“The Bank of England will be pleased to see that services inflation is starting to subside. They will also be reassured by the latest data indicating that private sector wage growth is easing,” said Jake Finney, an economist at PwC.

GBP

The pound fell on Wednesday after the release of UK inflation data. The Consumer Prices Index (CPI) rose by 10.1% in the twelve months to January 2023, down from 10.5% in December 2022. This reading also came in lower than what the market had predicted at 10.3%.

The decline of CPI saw Sterling fall and bond yields dropped as investors ‘priced out’ the extent of further interest rate hikes from the Bank of England.

Furthermore, the drop in core inflation, which excludes food and energy, confirms to the markets that the BoE may not be as hawkish moving forward. Core inflation year-on-year fell to 5.8% in January 2023, down from 6.3% in December 2022. This data came in also lower than market consensus which was 6.2%.

Money markets are now pricing in another interest rates rise of 25 basis points for next month, before the BoE decides to slow its monetary policy to see if inflation is indeed continuing its way down.

Sterling is likely to remain under pressure following the latest inflation reading. The market will now wait for BoE members to comment on policy rates moving forward.

Annual consumer price inflation (CPI) cooled to 10.1 percent last month, the lowest reading since September, the Office for National Statistics (ONS) said on Wednesday.

USD

The dollar rallied to six-week highs against a basket of currencies on Wednesday after the release of string Retail Sales data. This has bolstered investors expectations that the Federal Reserve will keep interest rates higher for a longer period of time to help bring inflation down. The data showed Retail Sales rose to 3% last month, the biggest increase in almost two years. The increase in Retail Sales was more than what the market was forecasting at 1.8%.

With the US economy performing well and a robust labour market, it is likely that the Feds projections, which suggested a peak rate of 5.1%, could be altered higher to 5.2% and above.

The market is starting to price in that the Fed may not cut interest rates this year, this is keeping the dollar well supported.