GBP: UK CPI miss sharpens BoE cut expectations

UK inflation has cooled to its lowest level in eight months, coming in below consensus and strengthening the case for a Bank of England rate cut on Thursday. Headline CPI slowed to 3.2% versus 3.5% expected (from 3.6%), while services inflation eased to 4.4%. The market response has been clear: sterling has unwound Tuesday’s two-month highs and is trading back nearer $1.33, with the narrative once again driven by relative rates and yields.

A 25bp cut would take Bank Rate to 3.75% and would likely drag 2-year gilt yields below that level, reinforcing downside risks for GBP. Pricing has shifted further towards easing, with markets now discounting roughly 68bp of cuts by end-2026 versus 58bp on Tuesday. Tuesday’s PMI beat offered a brief counterweight, with the composite flash estimate rising to 52.1 on stronger services activity and the best factory output increase in 15 months. Even so, a rising unemployment rate, cooler wage momentum and faster-than-expected disinflation leave the balance of risks skewed towards a more dovish BoE vote split, which would remain a near-term headwind for the pound. Services inflation is still too high for comfort, but a lower headline profile should help lean inflation expectations down over time.

USD: Front-end yields cap the dollar after softer labour signals

The dollar index is hovering near its lowest level since early October, tracking the decline in short-dated Treasury yields following yesterday’s US jobs data. Non-farm payrolls rose 64k in November, slightly above expectations, but sizeable downward revisions to October pulled the three-month average down to around 22k. The unemployment rate also rose to 4.6%, the highest since 2021, underlining a softer labour-market backdrop and supporting expectations for further Fed easing.

Retail sales provided a firmer counterpoint, with the October control group up 0.8% and suggesting household demand remains resilient. With growth signals mixed and rate expectations still sensitive, the next inflation release looks set to be the key catalyst for near-term USD direction and the scale of 2026 easing priced by markets.

EUR: ECB hold likely, with cycle-end pricing offering support

EUR/USD briefly reached $1.18 yesterday, its highest level since late September, before pulling back as the session progressed and USD demand returned. The European Central Bank is expected to hold rates at 2% on Thursday, and the broader shift towards viewing the easing cycle as largely complete should help limit further downside in the cross, even if near-term volatility persists.

Euro area activity data remain uneven. The composite PMI eased to 51.9, weighed by ongoing German industrial weakness, while France surprised with its strongest factory growth in more than three years. Germany’s ZEW expectations index rose to 45.8, the highest since July, pointing to improving sentiment even as the near-term growth profile stays soft.

Looking ahead

Thursday’s BoE decision is the focal point for GBP, with the CPI downside surprise increasing the risk of a cut and a dovish tilt. In the US, the next inflation print is likely to decide whether softer labour momentum translates into more aggressive easing expectations for 2026. For EUR, focus will be on whether the ECB reinforces a steady-policy message, leaving relative rate differentials as the main driver for the next leg in EUR/USD.