UK Inflation Drops to New Lows, Paving the Way for Potential Rate Cuts.

GBP: The UK Consumer Price Index (CPI) for September showed 0% growth, bringing the year-on-year rate down from 2.2% to just 1.7%, a new cycle low and well below the Bank of England’s (BoE) 2.0% target. While this is a positive sign in the battle against inflation, the real highlight is the drop in services inflation, which is critical in the BoE’s decision-making process. As ING points out, services inflation reflects domestic economic factors like wage growth, and its decline from 5.6% to 4.9% was better than expected. If services inflation remains under 5%, it could lead to a faster rate-cutting cycle than previously anticipated. With the BoE forecasting 5.3% by year-end, the current trends suggest this figure may be too high, opening the door to more aggressive cuts.

Governor Bailey has hinted at a potential acceleration in rate cuts if inflation continues to cooperate, though the bank is unlikely to follow the Fed or RBNZ in making 50 basis-point (bps) cuts unless the economy weakens significantly. The UK labor market, which showed no major signs of stress in Tuesday’s data, suggests that the cuts in November and December are more likely to be 25bps each. ING predicts 25bps cuts at each meeting next year until rates reach around 3.25%, which is considered the neutral level—neither restrictive nor stimulative. Despite expectations that CPI will rebound to around 2.5-2.7% due to fading natural gas price effects, as long as services inflation and wage growth remain under control, the BoE will likely have room to cut rates as needed. The pound reacted by dropping, with GBPUSD holding just above the 1.30 support level, while EURGBP rose to 0.838 and has room to climb further.

USD: The US Dollar (USD) faced challenges on Wednesday due to a lack of major economic data and increasing speculation that the Federal Reserve will continue cutting interest rates. Following last month’s 50bps rate cut, markets are almost certain that another 25bps cut will occur in November, leaving USD struggling to gain traction. The next major event for the Pound to US Dollar exchange rate will be Thursday’s release of US retail sales data, with expectations of a small increase from 0.1% to 0.3%. In the UK, a lack of significant data releases may leave GBP exchange rates quiet.

EUR: Paul Dales from Capital Economics expects the BoE to cut rates in November but sees no further changes in December. He predicts that rates will eventually fall to 3.00%, below the market’s current expectation of 3.50-3.75%. Meanwhile, fiscal policy is being closely watched, with reports suggesting Chancellor Reeves may announce a £40bn tightening in the late-October budget to address a £100bn fiscal gap. This could ease pressure on long-term yields and give the BoE more room to cut rates. The European Central Bank (ECB) is widely expected to cut rates again on Thursday, with potential for another reduction in December, though there’s a risk of disappointment if markets have overestimated the chances of deeper cuts.