UK CPI moderates as expected, as Pound stabilizes, and Lagarde’s future at ECB in question

UK inflation moderated as expected in January, and the headline rate was 3% for the start of the year, down from 3.4% in December. The biggest drivers of this decline include a decrease in petrol prices and a decline in airfare prices at the start of the year. Food price inflation also moderated, which pushed the headline CPI rate to its lowest level since March 2025.

CPI on track to fall to BoE’s target in Q2

This is expected to be the start of a large decrease in annual gains for headline inflation this year, and the Bank of England expects the headline CPI rate to return to the 2% target around April. Today’s data suggests that CPI is on track to meet the BOE’s forecast.

The core rate of price growth was slightly higher than expected at 3.1%, and service price growth fell a notch to 4.4% from 4.5% at the end of the year. The question now is, will today’s data show enough of a disinflationary trend for the BOE to cut rates at next month’s meeting?

March rate cut signed and sealed but not yet delivered after this week’s data

After yesterday’s weak labour market data, the interest rate futures market is now pricing in an 82% chance of a rate cut next month, with a second cut currently expected between September and November. UK interest rates are currently expected to end the year around 3.22%, this is down from 3.34% at the start of the year.

Labour market is key focus for BoE

A series of weaker economic data has caused a recalibration of expectations for UK interest rates, with the BOE now expected to cut rates faster due to the sharp deterioration in the UK’s labour market. While the BOE is still concerned about inflation, the labour market is likely to be a more acute concern for the Bank, as moderating wage growth boosts the outlook for CPI.

Government set to make another U-turn to ease unemployment fears

Hawkish BOE member, Catherine Mann, said in an interview last weekend that there is a link between the large rise in the minimum wage and rising youth unemployment. This supports the view that the Bank of England is focusing more on labour market concerns as the UK economy faces challenging conditions. The government also appears to be taking note of the BOE’s labour market concerns. The Times reported this morning that Labour ministers are considering ditching their manifesto pledge to pay young people the same minimum wage as older workers, due to the surge in youth unemployment in the UK. With one in six 18–24-year-olds out of work, the data justifies a rethink, and Starmer’s government could be about to embark on another U-turn, which could have an  impact on BOE policy in the future, if it eases the squeeze on hiring.

Pound stabilizes but remains vulnerable to a further sell-off

The pound has stabilized after Tuesday’s sharp sell off. GBP/USD is hovering around $1.3550 after today’s CPI report, this is just above the 50-day sma at $1.3530. We doubt that today’s data will provide much impetus to boost the pound, but the selloff may pause.

The dollar is making a comeback on Wednesday, and the dollar index is extending gains above 97.00 this morning. The pound’s performance has flipped, from being the worst performer on Tuesday, it is now the most resilient currency in the G10 FX space this morning, as the higher-than-expected core and service rate of UK inflation was less dovish than expected.

However, this does not disguise the fact that the pound is weakening as UK economic data deteriorates, and GBP is still the weakest currency in the G10 FX space so far this month. In the past week, the 10-year Gilt yield is lower by 10bps, which is eroding  support for the pound and leaves it vulnerable to further declines.

Euro weaker as Lagarde may not stay at ECB

Elsewhere, stock market futures are pointing to a higher open later today as the selling pressure linked to the AI scare trade stabilizes. The euro is selling off this morning after the FT reported that ECB chair Christine Lagarde would step down from her role early. This has been denied by the ECB, and the impact on the European bond market is negligible so far. However, it is worth watching this story, as the next chair of the ECB will determine the direction of Eurozone interest rate policy as the Eurozone economy slowly turns a corner.

Chart 1: GBP/USD, 50-day sma holds as support for now