Sterling drops on slowing British inflation, U.S. yields help dollar

LONDON (Reuters) – Sterling dropped against the dollar on Tuesday, suffering along with peers in the face of at least a temporarily resurgent greenback, while also being affected by the latest signs of slowing inflation in Britain.

The pound was last down 0.7% at $1.2637, as a move up in U.S. yields sent the greenback higher. The dollar index which tracks the greenback against six peers was up 0.7%.

That marked a reversal of recent trends and the pound reached a near five-month high of $1.2825 in late December as the dollar weakened.

The pound gained nearly 6% in 2023, on the back of less bad than feared economic data, and expectations the Bank of England would keep rates higher for longer, though a weakening economy and election uncertainty make a repeat performance unlikely.

The British currency was also softer, but less dramatically so, against the euro, which was up 0.13% at 86.75 pence.

The pound has been weakening against the euro in recent weeks as inflation data causes markets to bring forward expectations of Bank of England rate cuts. The BoE had previously been expected to lag the Federal Reserve and the European Central Bank.

“Data out this morning has seen little to upset this narrative either,” said analysts at Monex Europe.

Prices charged by British store chains rose at the joint slowest pace in a year and a half in December, the British Retail Consortium said on Tuesday.

Food price inflation cooled to 6.7%.

However, the Monex analysts sounded a note of caution for pound bears.

“Whilst the data is clearly disinflationary at the margin, market pricing for rate cuts in the UK continues to look a little aggressive to us,” they said.

“Progress on cooling price growth is set to slow over the coming months, and whilst we don’t rule out a rate cut from the BoE in Q2, on balance we suspect that inflation persistence will keep the BoE on hold into the second half of the year.”

Markets are fully pricing a 25 basis BoE rate cut in May and nearly 140 bps of cuts this year.

Investors were also digesting factory activity data from around the world on Tuesday.

Britain’s manufacturing sector suffered a setback in its attempts to return to growth as output and employment fell more sharply in December than the previous month, according to the final reading of the S&P Global/CIPS manufacturing Purchasing Managers’ Index (PMI)

Euro zone factory activity contracted in December for an 18th straight month.

(Reporting by Alun John, editing by Ed Osmond)