UK inflation accelerates in June, complicating BoE outlook

Annual inflation in the United Kingdom climbed to 3.6% in June, the highest reading since January this year and a step above both forecasts and May’s figure of 3.4%. The latest rise was driven primarily by higher costs for food and energy. However, underlying inflation, which excludes these more unpredictable elements, also exceeded expectations. Meanwhile, inflation in the services sector, often viewed as an indicator of domestic cost pressures monitored closely by the Bank of England, remained at 4.7%, again surpassing projections.

The balance of risks for sterling has shifted further towards weakness against both the US dollar and the euro. Domestic economic fragilities are now increasingly overshadowing the support offered by higher yields. Although the unexpected surge in inflation provided the pound with a brief lift earlier today, the boost could prove short-lived. Persistent price pressures, combined with sluggish growth, are fuelling concerns over potential stagflation.

These developments present a dilemma for the Bank of England, which is seeking firmer evidence that inflation is receding in parallel with a cooling economy. Such confirmation would be needed to justify reducing interest rates as soon as August. Following today’s figures, traders have pared back expectations for rate cuts this year. Nevertheless, Governor Andrew Bailey has signalled that monetary easing remains on the agenda. He recently pointed to notable falls in employment linked to recent fiscal measures enacted by the Labour government, such as higher payroll levies and the April rise in the minimum wage. As a result, investors are likely to focus intently on tomorrow’s official employment data, which could prove decisive for the BoE’s near-term course of action.

Despite this morning’s bounce, the pound remains under pressure, with GBP/USD set for a third consecutive weekly decline, down over 2% so far in July. Although the currency pair has been in an upward trend since touching a low of $1.21 in January, the 21-day moving average is now pointing lower. This shift suggests greater vulnerability to a deeper retracement. A fall towards the 100-day moving average at $1.3267 could mark the definitive end of this year’s recovery trend.

Dollar strengthens as yields climb after mixed US inflation data

The US dollar started yesterday on the back foot following the inflation report but soon reversed course, extending its winning streak to a seventh session as Treasury yields surged, with 30-year rates topping 5%. Although headline figures matched forecasts, underlying data revealed stubborn price pressures, challenging hopes that inflation is easing decisively.

Annual inflation picked up to 2.7% in June, up from 2.4% in May, exactly as expected. Monthly CPI rose by 0.3%, the fastest gain in five months. Core inflation increased 0.2% on the month, a softer reading, but the annual rate reached 2.9%. Markets initially welcomed the figures, with risk assets rising and yields falling, but sentiment quickly shifted once investors scrutinised the details.

Beneath the surface, all major components – core goods, services, food, and energy – rose together for the first time since February. Excluding cars, core goods prices leapt 0.55%, the sharpest increase since November 2021, reflecting higher import costs from tariffs. Supply chain pressure indices have also edged higher, while costs are rising in metals, freight, and food.

These trends suggest the Federal Reserve’s inflation challenge is not yet resolved. Market expectations for a September rate cut have fallen from over 90% to around 50%. If price pressures persist, the Fed may delay easing, which could underpin the dollar further, especially against currencies from more dovish central banks.

Euro slips further as dollar strength persists

The euro fell sharply against the dollar yesterday. After sliding below the $1.1660 support level, there was little to prevent further losses until just under $1.16. The EUR/USD pair settled near a three-week low around $1.1590. Several factors are combining to keep the outlook for the single currency under pressure in the near to medium term.

First, the latest US inflation figures provided fresh support for the dollar. The monthly headline CPI rose by 0.3%, exactly as foreseen, but those forecasts had already accounted for an expected tariff-driven surge over the summer, following a 0.1% increase in May. Confirming that rise was enough to extinguish any remaining speculation about rate cuts in the coming months. As tariff negotiations remain unresolved, the Federal Reserve is even less likely to ease policy soon, leaving the dollar firmly supported by wider yield differentials.

Second, sentiment is leaning further in favour of the dollar. Ongoing trade tensions are reinforcing this view, as many investors believe the eventual impact of tariffs will prove less damaging than initially feared. This perception has bolstered confidence in the greenback’s resilience.

Lastly, the only potential lifeline for the euro lies in forthcoming US economic data. If there are indications that tariffs are starting to weigh on American growth, the elevated inflation reported in June could be seen in a more troubling light. Such a scenario might revive worries about stagflation and could prompt renewed selling of the dollar. Attention now turns to tomorrow’s industrial production report and Thursday’s retail sales figures, which will offer fresh clues.

For the moment, EUR/USD is likely to stay under downward pressure. A clear break below the $1.16 threshold would open the way towards $1.1400, signalling scope for further losses in the euro.