Following the CPI report, EUR/GBP surged by +0.43% in the first hour—a notable reaction unseen in the past year.

The pound’s recent downturn, fuelled by the release of November’s UK CPI report, has positioned EUR/GBP at the 200-day moving average of 0.8660, while cable retreated to post-FOMC levels, hovering between 1.2600 and 1.2650. This decline was expected, given the substantial negative inflation surprise reported by Bloomberg—the most significant since March 2021 for headline inflation and since September for core inflation.

Following the CPI report, EUR/GBP surged by +0.43% in the first hour—a notable reaction unseen in the past year. The intensified pound sell-off challenges the belief that the Bank of England (BoE) would lag the ECB and Fed in rate cuts next year. Previous assumptions of higher inflation risks in the UK, making the BoE more cautious, are now questioned as evidence suggests a swift decrease in UK inflation, mirroring trends in the US and euro-zone, albeit with a lag.

Over the last six months, UK core inflation plummeted to 2.4% in November from its peak of 9.6% in July. While UK monthly data can be volatile, the evident improvement in underlying inflation is challenging for Monetary Policy Committee (MPC) members to dismiss. Positive news surfaced as Cornwall Insight projected a 14% reduction in Ofgem’s cap on domestic energy bills in April 2023, aligning with the decline in wholesale gas prices since mid-November. These developments reinforce expectations of headline inflation reaching the BoE’s 2.0% target in H1 2023, potentially paving the way for BoE rate cuts from Q2.

Challenges and Risks: Despite alignment with our BoE policy forecasts, the accelerated decline in inflation poses risks to short-term pound predictions. The faster-than-expected drop in inflation could impact the pound’s performance against other currencies. As the BoE’s cautious approach is questioned, investors reassess expectations compared to the more proactive stances of the ECB and Fed. The recent surge in EUR/GBP post-CPI underscores the market’s re-evaluation of the BoE’s position.

The aftermath of the UK CPI report triggers reactions in currency markets, intensifying pressure on the pound due to unexpected inflation dynamics. This challenges the previous belief in the BoE’s cautious stance, potentially opening the door for rate adjustments. The intersection of economic data, central bank policies, and market sentiment will continue to shape the pound’s trajectory, demanding vigilance from investors and analysts in navigating evolving dynamics.

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