Euro Trims Gains vs Pound After UK CPI Inflation Rises to 2.9%

The euro/sterling pair gave up gains in early European trading on Wednesday after a brief spike, last trading at 0.85569. Earlier data showed UK inflation unexpectedly accelerated, cooling market expectations for near-term rate cuts by the Bank of England and underpinning demand for the pound.

**Hotter-than-expected inflation data dents rate cut bets**

The latest data showed the UK CPI rose to 2.9% year-on-year, above the 2.8% expected by markets. The reading broke the prior trend of steady disinflation, prompting traders to quickly pare bets on further BoE rate cuts. Money market pricing showed expectations for the scale of rate cuts this year have narrowed notably versus before the data release. As a result, the pound strengthened broadly against major currencies, with the euro/sterling pair retreating from session highs.

**Eurozone's own inflation pressures also building**

Meanwhile, the eurozone is also facing the challenge of an inflation rebound. According to data previously released by Eurostat, the eurozone's July CPI also rose to 2.9% year-on-year, with core CPI unexpectedly ticking up to 2.5% from 2.4%. Energy prices surged 10% year-on-year, driven by geopolitical conflicts, becoming the main driver of the latest inflation uptick. Interest rate swap market data showed traders are pricing in roughly an 85% probability of a European Central Bank rate hike in September. With both major economies facing sticky inflation simultaneously, the euro/sterling pair's trajectory now hinges more on the divergence in their respective central banks' policy paths going forward.

**Short-term rangebound trade likely**

Bert Colijn, chief economist at ING, noted that if oil prices hold at current levels, eurozone inflation still has upside room in the coming months. In the UK, the upside inflation surprise makes the Bank of England more cautious on easing policy. Market reports showed that for the first time since early April, money markets are leaning toward pricing in further delays to rate cuts. With the monetary policy outlook for both sides clouded by uncertainty, the euro/sterling pair is unlikely to stage a sustained directional move in the near term, with the exchange rate likely to remain rangebound around current levels.