Global inflation rises, tempering expectations for rate cuts as Sterling strengthens, Euro and USD weaken.

UK

In December, the annual rate of consumer price inflation (CPI) in Britain accelerated for the first time in 10 months, reaching 4.0% from November's more-than-two-year low of 3.9%. This unexpected uptick dealt a blow to market expectations for an early Bank of England rate cut. Factors such as a substantial increase in tobacco duty and a more pronounced impact from seasonal airfare hikes contributed to this rise, contrasting with the anticipated decline to 3.8% according to a Reuters poll of economists.

Following the release of this data, Sterling strengthened. This has resulted in the increased bet that the Bank of England (BoE) would commence rate cuts by mid-May, down from just over 80% late on Tuesday. The BoE had raised interest rates 14 times from December 2021 to August 2023, peaking at a 15-year high of 5.25% in response to inflation surging to a 41-year high of 11.1% in late 2022, proving slow to decline thereafter.

However, inflation started to decrease more rapidly than anticipated in the latter months of the preceding year. This prompted many economists to predict that inflation would return to the BoE's 2% target by April or May of the current year, approximately 18 months sooner than the BoE's initial projections. The December increase in Britain's inflation rate followed similar upticks in the euro zone and the United States. Notably, unlike earlier in 2023, British inflation is no longer significantly higher than in other large, advanced economies.

EUROZONE

In December 2023, the annual inflation rate for the euro area increased to 2.9%, compared to 2.4% in November. One year prior, the rate stood at 9.2%. Similarly, the European Union's annual inflation rose to 3.4% in December 2023, up from 3.1% in November, with a year-on-year rate of 10.4% in the same period last year. Notably, services made the most significant contribution to the annual inflation rate in the euro area in December (+1.74 percentage points), followed by food, alcohol & tobacco (+1.21 pp), non-energy industrial goods (+0.66 pp), and energy (-0.68 pp).

In the latest developments, European markets experienced a slight downturn on Wednesday, fueled by investors reevaluating their earlier predictions of imminent interest rate cuts by major central banks. Despite several weeks of efforts by various European Central Bank (ECB) speakers to challenge prevailing market expectations, it seems that only Christine Lagarde has been successful in bringing a sense of reason to the markets.

The EUR/USD pair stabilised around the $1.0850s, reaching a new 5-week low, primarily influenced by broader strength in the USD. In other movements, the EUR/GBP pair declined to a 1-week low, driven by a resurgence in the British Pound following the release of higher-than-expected December UK Consumer Price Index (CPI) figures.

US

Following the release of U.S. retail sales data for December that exceeded expectations, the Dollar exhibited strength against the Pound, Euro, and other major currencies.

The Dollar attracted renewed buying interest as it was disclosed that retail sales experienced a month-on-month increase of 0.6%, surpassing the consensus forecast of 0.4%. Notably, the control group of retail sales recorded a more robust growth of 0.8% month-on-month, exceeding expectations of 0.2%. This strength was widespread, with increases observed in 9 out of the 13 categories.

Significant rises were particularly evident in discretionary categories such as clothing, non-store retailers, and general merchandise. Investors, in response to this positive economic data, have adjusted their expectations regarding the timing of the first interest rate hike, anticipating a more gradual approach compared to the initial projections at the beginning of the year.

The GBP to USD exchange rate reached a peak of 1.2698 earlier in the day but retreated to 1.2645 following the release of the retail sales figures. Similarly, the EUR to USD pair extended its losses for the day, reaching 1.0859.