Sterling fell on Wednesday after data showed UK inflation unexpectedly slipped to a three-year low during December, ramping up expectations that the Bank of England (BoE) will cut interest rates later this month.
The consumer price index (CPI) rose 1.3 per cent last month compared to a year earlier — the weakest level since November 2016, according to official data released this morning.
The weak CIP reading means inflation slipped further away from the Bank’s official two per cent target, fuelling speculation about an imminent rate cut by its monetary policy committee (MPC).
Sterling fell as much as 0.25 per cent against the dollar to $1.2985 following the unexpected drop in inflation. It later regained some ground, and was sitting just above $1.30 by early afternoon.
Bloomberg data on swaps trading shows market odds of a quarter point rate reduction have hit 62 per cent, compared to less than five per cent last week.
British government bond prices also shot up following the reading, with traders taking the drop as a sign the Bank would move to cut rates.
Outgoing BoE governor Mark Carney struck a dovish tone in a speech last week, indicating that the central bank could cut rates if economic weakness persisted.
Fellow MPC committee members Gertjan Vlieghe and Silvana Tenreyro have both all recently suggested they would back rate cuts if the Conservatives’ decisive December election victory does not boost the economy.
Rate-setter Michael Saunders — who voted in favour of cutting rates in December — restated his support for the policy in a speech in Northern Ireland this morning.
“This gives the Bank of England all the excuse it needs to cut later this month,” said Markets.com chief analyst Neil Wilson.
“Coming off the back of those weaker GDP and industrial production numbers, it does not look as though the economy was firing on all cylinders at the tail end of last year. While there may well be a Boris Bounce in the offing, I rather think the die is cast in favour of a rate cut.”
The cost of overnight hotel stays provided downward pressure on inflation in December, with prices dropping 7.5 per cent.
Clothing and footwear also provided pressure amid the increased competition faced by high street stores.
Women’s clothing saw the most significant price cuts, with 15 per cent of items reduced as opposed to 11 per cent a year earlier.
“A relatively mediocre Christmas trading period may go some way to explain why inflation is still languishing below its two per cent target,” said Robert Alster, head of investment services at Close Brothers Asset Management
Read more: Bank of England rate-setter hints at cut
“These figures back up outgoing Bank of England Governor Mark Carney’s suggestion that there is clear headroom to cut interest rates to stimulate the economy if required.”
“However, with Brexit-linked uncertainty improving and wage growth outstripping inflation, CPI could soon creep closer to target. This might make a rate cut more unpalatable,” he added.