Sterling falls as weak inflation data fans BoE rate cut expectations

LONDON (Reuters) - Sterling fell on Wednesday after data showed UK inflation rose at its weakest rate in three years, ramping up expectations of a rate cut from the Bank of England at its January meeting.

FILE PHOTO: UK pound coin drops into yellow watercolour in this illustration picture, October 26, 2017. REUTERS/Dado Ruvic/Illustration

Consumer prices rose at an annual rate of 1.3% in December compared with 1.5% in November, marking the smallest increase since November 2016. This compared with analyst expectations for a rise of 1.5% rise, according to a Reuters poll.

The numbers brought Britain’s currency under further pressure. It has fallen in recent days after several policymakers, including Bank of England governor Mark Carney, hinted they could vote for a rate cut unless economic data improves significantly, raising expectations of a cut at the bank’s Jan. 30 meeting.

These expectations increased further with weaker-than-expected economic growth and industrial production data this week.

Sterling was down a fifth of a percent against the euro at 85.65 pence, around a fifth of a percent lower on the day and within sight of seven-week lows touched on Tuesday.

The pound fell as much as 0.25% to $1.2985 following the inflation data. It later recovered against a broadly-softer dollar to around $1.30, little changed on the day.

Money markets are pricing in roughly a 60% chance of a 0.25% cut at the BoE’s January meeting, compared with 49% prior to the inflation reading.

“The number of doves is building and the data is supportive of rate cuts; so it’s a question of at which meeting,” said Kit Juckes, head of FX strategy at Societe Generale.

Prior to the inflation release, BoE interest rate setter Michael Saunders said he was sticking to his view that borrowing costs should be cut because of weakness in Britain’s labour market and its broader economy.

“With limited monetary policy space, risk management considerations favour a relatively prompt and aggressive response to downside risks at present,” he said.

Saunders’ view of limited room to adjust policy came in contrast to Carney’s statement last Friday, when he said combining possible interest rate cuts and the prospect of more asset purchases made the BoE’s current armoury the equivalent of cutting the Bank Rate by 2.5 percentage points.

“We expect two more rate cuts from the Bank of England,” said Wouter Sturkenboom, chief investment strategist for EMEA at Northern Trust Asset Management.

“Now that Brexit has been decided, they (BoE policymakers)finally have the political backdrop that allows them to respond to what they should have been responding to earlier in 2019, which is a weak growth and the inflation environment.”

In a further sign of building UK rate-cut expectations, British gilt yields fell sharply.

The 10-year gilt yield was down almost 8 basis points on the day at 0.65%, having hit its lowest level since November. It was set for its biggest daily fall since early September.

Reporting by Yoruk Bahceli and Dhara Ranasinghe; Editing by Alex Richardson and Hugh Lawson