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Rally in UK gilt yields pauses after soft inflation data

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The EURGBP pair edged lower to 0.8440 in Wednesday’s North American session, as the five-day rally in the cross that was built on surging yields on UK gilts appears to be losing fuel.

The 30-year gilt yields tumbled from their more-than-26-year high of 5.47% to 5.38% after the release of the soft Consumer Price Index (CPI) report for December, which led to a recovery move in the Pound Sterling.

The UK CPI report showed that the core inflation – which excludes volatile items, such as food, energy, oil, and tobacco – grew by 3.2%, slower than estimates of 3.4% and the former reading of 3.5%. Annual headline inflation surprisingly decelerated to 2.5% from 2.6% in November. Economists expected the underlying inflation data to have accelerated to 2.7%.

Signs of cooling price pressures have prompted expectations for the Bank of England to cut interest rates in February’s policy meeting. Markets currently see an 84% chance of the BoE cutting rates by 25 basis points (bps) on February 6, compared to a 62% chance at Tuesday’s close.

Technically, cooling inflationary pressures weigh on the currency. However, Sterling rebounded as it was declining sharply for a week due to surging gilt yields.

Investors were dumping government bonds as they lacked confidence in the UK economic outlook due to stubborn price pressures and a likely trade war with the US, given that President-elect Donald Trump will raise import tariffs sharply. This scenario would heavily weigh on the UK’s exports.

Investors expected a sharp rise in the UK government’s borrowing costs would force the administration to cut spending heavily.

Meanwhile, the Euro broadly underperformed on Wednesday as European Central Bank officials are comfortable with market expectations for the central bank to deliver at least three interest rate cuts this year.

Trades have priced in a significant number of ECB rate cuts as the Eurozone inflation has broadly remained under control.

ECB policymaker and Governor of the Bank of France François Villeroy de Galhau said οn Wednesday, “it makes sense for interest rates to reach 2% by the summer” as we have practically won the “battle against inflation”.

(Source: OANDA)