Sterling Slides as UK Inflation Cools More Than Expected

The latest UK inflation data for February came in lower than anticipated, leading to a decline in the value of the British Pound against the Euro, Dollar, and other major currencies. According to the Office for National Statistics (ONS), the Consumer Prices Index (CPI) inflation rose by 0.4% on a monthly basis, falling short of the forecasted 0.5%.

On an annual basis, CPI inflation dropped to 2.8% from January’s 3.0%, defying expectations of a more modest decline to 2.9%. The primary driver of this slowdown was the clothing and footwear sector, which recorded a year-on-year price decline of 0.6%—its first negative reading since October 2021.

Services inflation, a key metric monitored by the Bank of England, remained unchanged at 5.0%, while core CPI inflation, another critical measure, eased to 3.5% from 3.7%—again undershooting expectations of 3.6%.

Despite inflation remaining well above the Bank of England’s 2.0% target, the lower-than-expected figures prompted a market reaction. The Pound weakened following the announcement, with the Pound-to-Euro exchange rate slipping from 1.20 to 1.1982, and the Pound-to-Dollar rate falling from 1.2940 to 1.2920.  The data has fuelled speculation of a further interest rate cut by the Bank of England in May, with traders now assigning an 80% probability to such a move. The increasing likelihood of a rate cut has coincided with a dip in UK bond yields and a weaker Pound.

However, the Bank of England remains constrained in its ability to aggressively reduce rates, as inflationary pressures persist. Economists caution that inflation could climb again, driven by rising National Insurance contributions and increasing energy and water costs.  Andrew Sentance, a former member of the Bank’s Monetary Policy Committee, has warned that CPI inflation could exceed 4% in the coming months, suggesting that "5% or more is on the cards for the autumn."

With inflationary forces still at play, the downside for UK bond yields and Sterling may be limited in the near term.

Treasury Faces Tough Choices as Spring Statement Approaches

With the Spring Statement on the horizon, Shadow Chancellor Rachel Reeves is focused on recovering the £10bn in ‘headroom’ that has been lost. To achieve this, the Treasury is expected to scale back its future spending plans, with new welfare cuts already anticipated. The remainder of the savings is likely to be found through reductions in departmental budgets.

However, spending cuts alone may offer only a short-term solution to deeper fiscal challenges. According to the International Monetary Fund (IMF), the UK has experienced the steepest rise in gross government debt among 40 advanced economies.

This surge in debt is largely attributed to sluggish economic growth and the lasting financial impact of government measures taken during the pandemic, alongside rising energy costs. In a climate of slow growth and elevated interest rates, reducing public debt as a proportion of GDP is becoming an increasingly difficult task.

US Dollar Struggles as Economic Uncertainty Grows

The US Dollar remains on course for its worst monthly performance in over a year, with a decline of 3.2%.

Optimism that Trump’s tariffs would bolster US economic growth has now given way to concerns over stagflation and recession, as investors grow increasingly doubtful about the administration’s economic approach. Consumer confidence took a sharp downturn in March, with the Conference Board’s index falling to 92.9—its lowest reading in four years. The expectations component suffered an even steeper decline, dropping nearly 10 points to a 12-year low, signalling heightened anxiety among households over rising prices and worsening economic conditions.

Federal Reserve officials, meanwhile, continue to adopt a cautious stance. Governor Adriana Kugler pointed to an increase in inflation expectations and higher goods prices, reinforcing the central bank’s reluctance to ease monetary policy too soon. Her remarks suggest that policymakers remain wary of premature rate cuts, particularly given recent inflation surprises that have kept concerns over price pressures alive.

Adding to market uncertainty is the lack of clarity surrounding US trade policy. Trump hinted on Monday that some of his proposed tariffs might not take effect on 2 April, sparking speculation that the administration could take a more flexible approach. However, his decision to introduce “secondary tariffs” on countries purchasing Venezuelan oil has injected further unpredictability into US trade relations, raising fears of wider economic and diplomatic consequences.

Euro’s Prospects Remain Mixed Amid Tariff Uncertainty

While the euro has faced recent pressure, supportive fiscal and monetary policies are expected to drive further gains in the future or at least mitigate some of the impact of US tariffs on the Eurozone. Investor confidence and business activity in the region are showing signs of improvement, pushing bond yields higher. However, currency traders remain cautious ahead of Trump’s impending tariff deadline next week, particularly as the euro is set for its strongest monthly performance in over two years—making profit-taking a likely scenario.

Lingering uncertainty over Trump’s retaliatory tariffs could keep demand high for safe-haven assets, including the US dollar, in the coming days. As with many of Trump’s policy decisions, the situation remains fluid, with no outcome certain until the president makes an official announcement.

Nonetheless, Germany’s historic stimulus measures and the broader Eurozone’s proactive fiscal policies could help cushion the economic blow from tariffs, reducing potential downside risks for the euro. However, given its recent strength, some of the euro’s upside may already be factored into market pricing.