Pound Weakens as Inflation Slows

The British pound recorded its biggest one-day drop in a month after inflation data came in softer than expected. According to the Office for National Statistics, consumer prices rose 3.2% year-on-year in November, down from 3.6% in the previous month. The reading was below economists’ expectations of 3.5% and the Bank of England’s own projection of 3.4%, reinforcing expectations of a more accommodative monetary stance.

Markets increase bets on BoE rate cuts

Following the release, sterling fell 0.8% to $1.3316, its lowest level in a week. UK 10-year government bond yields dropped seven basis points to 4.45%, signaling increased demand for fixed income. Money markets now price 67 basis points of rate cuts by the end of next year, up from 58 basis points before the data, reflecting stronger conviction that policy easing is ahead.

Price dynamics and investor reaction

The sharper-than-expected slowdown in inflation was largely driven by falling prices in certain food categories, including cakes, biscuits and breakfast cereals. In response to the data, hedge funds sold the pound in the spot market against both the euro and the dollar, while rates traders added to positions favoring further easing by the central bank.

Rate expectations largely priced in

Despite the shift in expectations, markets are not anticipating significant near-term volatility. One-day implied volatility in sterling remains around 10%, suggesting that a potential rate cut by the Bank of England is mostly priced in. Short-term options positioning has turned more bearish on the currency, with risk reversals indicating a premium for the US dollar.

As International Investment experts report, the sharper-than-expected decline in inflation strengthens the case for Bank of England rate cuts and puts short-term pressure on the pound. However, the durability of the move will depend on upcoming inflation data and policy signals, as a large part of easing expectations is already reflected in current market pricing.