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The Pound to Dollar exchange rate (GBPUSD) was broadly softer as investors reacted to signs the UK remains particularly afflicted by elevated inflation, raising concerns for the economic outlook.
GBPUSD spiked as an initial reaction to ONS data that showed inflation had fallen back into single digits and remained well above where investors and the Bank of England were expecting.
The exchange rate then retreated and ended the day lower amidst an ongoing trend of dollar appreciation and as investors queried the UK economic outlook in the face of sticky inflation.
"Market pricing for the Bank of England’s policy interest rate has also increased sharply. Almost 100bp of hikes is now priced. The reason for the fall in GBP/USD reflects the stronger USD and perhaps also concerns that several more interest rate increases will push the UK economy into recession," says Joseph Capurso, an analyst at CBA.
GBPUSD rose to 1.2469 before retreating back to where we find it at the time of writing at 1.2347 on Thursday.
"Sterling fell to new one-month lows against the greenback as the dust settled following Britain’s latest monthly snapshot of inflation," says Joe Manimbo, Senior FX Analyst at Convera.
Headline CPI printed at 8.7% in the year to April, down from 10.1% in March, but well above the 8.3% reading the market was looking for and above the Bank of England's forecast for 8.4%.
Bond yields and the Pound initially rose in tandem as money markets revealed investors had raised their bets for the peak in the Bank of England's interest rate to 5.5% by year-end; this after core CPI inflation read at 6.8% year-on-year, which is above expectations for 6.2%.
"On the bright side, headline inflation cooled below 10% for the first time in eight months by printing at an annual pace of 8.7% in April. But that topped forecasts of 8.2%, while the core reading unexpectedly accelerated to 6.8%, the highest in over three decades, from 6.2%," says Manimbo.
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He adds that the "still hot reading" cements expectations for the Bank of England to raise rates from 4.50% in June.
In fact, markets are now pricing in a further three hikes, something that would have once been supportive of Sterling's outlook.
Manimbo explains that rising rate expectations are "on the surface" a "positive for the pound's yield allure but can intensify the headwinds on the economy that ultimately is not good for sterling."
Above: GBPUSD at four-hour intervals.
The market is therefore starting to query whether the UK economy is unique in that it faces a particularly acute inflationary problem.
If this is judged to be the case we could see UK assets, such as the Pound come under pressure.
The Dollar meanwhile continues on its rebound that is pressuring Pound-Dollar lower.
"There is a sense of caution in the air, with equities sliding yesterday and the dollar finding some demand through the safe-haven channel," says Marios Hadjikyriacos, Senior Investment Analyst at XM.com.
The Dollar is meanwhile finding support as investors raise bets the Federal Reserve must hike rates again.
"Market pricing currently assigns roughly a 50% probability for the Fed to raise rates by July, while the rate cuts that were baked in for the remainder of the year have been mostly unwound following a streak of encouraging data releases," says Hadjikyriacos.
This recalibration of the trajectory for interest rates was clearly reflected in the Dollar and U.S. yields, which have risen over the course of May, bringing to a close a period of underperformance.
"Rates markets are in the driving seat once again as the week has progressed – the steady grind back higher in US yields has underpinned the USD for the last couple of weeks," says a regular briefing update from the currency strategy desk at Goldman Sachs.
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