Inflation, Currencies, and Central Bank Dynamics.
USD: Will Core CPI Run Hot Again?
A softer-than-expected US PPI print yesterday briefly pressured the dollar, with core PPI registering 0.0% MoM. While this directly influences the Fed’s preferred inflation metric (core PCE), it doesn’t guarantee today’s core CPI will follow suit.
Key drivers of a potential hot CPI include rising airline fares and car rental prices, as noted by our US economist. With consensus expectations split between 0.2% and 0.3% MoM, the average forecast (0.25%) rounds up to 0.3%, aligning with our call. A 0.3% result would likely be interpreted as hawkish by the Fed, supporting dollar strength.
Adding to dollar softness yesterday was news that Trump’s advisors are considering gradual tariff hikes (2-5% monthly) to control inflationary effects and maintain leverage in trade negotiations. While this less aggressive approach may reduce immediate inflationary risks, markets remain cautious about the broader implications of US protectionism.
EUR: Temporary Rebound Amid Dollar Headwinds
EUR/USD edged back to 1.030 following USD-negative developments, but we expect US CPI to renew pressure on the pair. With no significant eurozone data due, the focus remains on ECB speakers.
A short-term fair value model suggests a 2.5% risk premium on EUR/USD tied to US protectionism concerns. However, we don’t foresee this gap closing significantly without a shift in rate differentials. Even a 0.3% MoM US core CPI may struggle to push EUR/USD sustainably above 1.020 for now.
GBP: Slowing UK Inflation Offers Relief for Gilts
UK inflation data brought some much-needed relief for the gilt market. Services CPI—closely watched by the BoE—eased to 4.4% (vs. 4.8% consensus), with core CPI falling to 3.2% and headline CPI to 2.5%.
This slowdown supports our forecast of a 25bp BoE rate cut in February, reinforcing expectations for a dovish shift in the Sonia curve. Despite soft inflation, the pound held steady, reflecting its heightened sensitivity to long-term borrowing costs over short-term monetary policy signals.
EUR/GBP gains yesterday were driven by euro strength rather than sterling weakness. While UK bond recovery may stabilize GBP in the near term, the CPI print suggests BoE rate cuts ahead, which could lead to sustained pound depreciation over the coming months.