Last week saw a mix of data in the UK, as headline inflation unexpectedly rose to 4.0%, while average earnings growth slowed to 6.5%. Inflationary pressures have significantly eased, and a resumption of the downward trend is anticipated in the coming months. Despite economic headwinds, the job market remains relatively robust, with unemployment holding steady at 4.2%.

Expectations for rate cuts in the UK have been scaled back by the markets, with approximately 1% of cuts currently projected by the year-end.

In Europe, headline inflation met expectations at 2.9%, and markets are factoring in potential rate cuts of up to 1.40%, given the persistently weak underlying economic fundamentals.

In the US, forecasters are still pricing in up to 1.50% of rate cuts for the year, possibly beginning in March, as the Federal Reserve shifts its focus from inflation to growth.

While the outlook for interest rate differentials continues to influence market sentiment, central bank policymakers are pushing back against the market's aggressive pricing for rate cuts, citing unprecedented uncertainty. This resistance is impacting global equity markets and pushing yields higher.

Geopolitical concerns remain at the forefront of investors' minds due to the escalating tensions. Disappointing Chinese growth data is weighing particularly on the European economy, and authorities are likely to implement additional economic stimulus.

Looking ahead to next week, there is little in terms of data, and no changes are expected at the European Central Bank meeting. Consequently, political events are likely to be the driving force behind market momentum.

This morning, the attention of British investors was fixed on the retail sales report, where the unexpected drop in nominal wage growth and the inflation number surpassing predictions introduced conflicting data points for interpretation. The highly awaited macroeconomic week wrapped up with the Office for National Statistics revealing a significant 3.2% decline in December retail sales, marking the steepest fall since January 2021 and defying economists' expectations of a mere 0.5% contraction. The downturn was widespread, impacting food stores negatively, while department stores and goods retailers expressed concerns about sluggish demand. The year concluded with an annual growth rate of -2.8%, marking the lowest sales figure since 2018.

The repercussion on the pound is noteworthy. Our foresight regarding both the likelihood of data disappointments this week and the pound's resilience to such data has been validated. Although GBP/USD exhibited a modest reaction to the three macro releases this week, the correlation between sterling and global risk sentiment, along with Federal Reserve pricing, proved more influential than regional data. The data discrepancies, including the unexpected upside in UK CPI, are unlikely to sway the Bank of England decisively in either direction. This elucidates the restrained price dynamics of the currency pair, which remained within a narrow range of 1.8% over the past five weeks, oscillating between $1.26 and $1.2870.

Beyond the US dollar and euro, the pound has demonstrated strength against other currencies, showcasing its resilience amid high inflation and escalating short-term yields. The GBP is anticipated to appreciate for a fourth consecutive week against the Swedish krona, Australian dollar, and Canadian dollar, while also concluding the third successive week on a stronger note against the Japanese yen, Swiss franc, and Norwegian krone.

European markets experienced a slight decline on Wednesday as investors hesitated on their earlier predictions of imminent interest rate cuts by major central banks. Despite numerous attempts by various European Central Bank (ECB) speakers over the past weeks to counter prevailing market expectations, it seems only Christine Lagarde has been successful in injecting some rationality into the situation.

During an interview at Davos, the ECB President indicated that the central bank's initial rate cuts are likely to occur in the summer. Lagarde emphasized the need for additional evidence of disinflation before justifying a more accommodative policy. Knot, a member of the Governing Council, also commented that markets have exaggerated the anticipated extent of rate cuts, unintentionally causing financial conditions to loosen and raising the risk of a necessary hawkish response from the central bank. This warning echoed other hawkish signals observed earlier in the week.

Despite the mixed messaging, the Governing Council did find common ground on one aspect – there won't be any rate cuts in the immediate future. Consequently, Eurozone bond yields rose across the curve as markets scaled back their expectations of rate easing by the ECB. The likelihood of a rate cut in April decreased to 75%, and money markets adjusted their cumulative rate cut projections for 2024, pricing in 134 basis points (-16 basis points day-to-day) of easing. This translates to five quarter-point cuts, a reduction from the six cuts anticipated the previous week.

In summary, the Stoxx 50 index dropped 1.2% to its lowest level since late November, and the German 10-year Bund yield continued its ascent to 2.3%, reaching its highest level since December 8th. The optimism for rate cuts wavered, leading to these market movements. Concurrently, the euro depreciated against the US dollar for the fifth consecutive day, settling around the 200-day Simple Moving Average (SMA) of $1.0850s – a fresh 5-week low driven by overall USD strength. In other currency pairs, EUR/GBP hit a 1-week low as the British Pound rebounded following higher-than-expected December UK CPI figures. Despite the confusion in ECB messaging, the common currency benefited against most other G10 peers, with EUR/JPY and EUR/CHF gaining 0.6% and 0.5% day-to-day, respectively.

Yesterday marked the GBP's most challenging day in a fortnight, as it succumbed to a surge in USD strength and disappointing nominal wage data. These factors caused the currency to dip below the support lines established in November and October of the previous year. However, the resilience exhibited in today's inflation data has prevented GBP/USD from falling below the 50-day moving average at $1.26, a level briefly touched just before the release of the Consumer Price Index (CPI). As of now, the currency pair is trading around $1.2630, maintaining its strength against non-dollar counterparts. GBP/AUD is particularly noteworthy, poised to register its tenth appreciation in eleven days, reflecting a 3.5% increase during this period. GBP's superior performance against the yen stands out, with a notable 4.3% surge since January 3rd.

Delving into the CPI figures, December witnessed the first uptick in inflation in the United Kingdom after a ten-month streak of disinflation. Consumer prices rose by 10 basis points year-over-year, reaching 4%, while core inflation remained elevated at 5.1%. The closely monitored services inflation also saw an increase from 6.2% to 6.4%, completing a trifecta of robust inflation prints. Although the December uptick in price pressures is not entirely favourable, much of the upward movement can be attributed to base effects. Despite this, our outlook anticipates a gradual decline in inflation over the upcoming months, aligning with the expectation that the Bank of England will initiate a monetary policy easing starting from May onwards.