Sterling holds steady as UK inflation keeps Bank of England in focus

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Sterling steady as UK inflation focuses BoE

Highlights

UK headline consumer price inflation rises to 3.1% in August, highest since March, while core inflation remains at 2.6% for fourth month.
Sterling trades at $1.3471 versus the dollar and 85.66 pence per euro, holding steady near one-month lows after inflation data release.
Markets price in just a 20% chance of a BoE rate hike to 4% on Thursday, with full rate increase expectations shifted to November.

Inflation data and market pricing

As reported by Reuters, official figures show UK headline consumer price inflation rises to 3.1% in August from a year earlier, the highest level since March, while core inflation holds at 2.6% for a fourth straight month.

That combination leaves the pound little changed on Wednesday, trading at $1.3471 against the dollar and at 85.66 pence versus the euro. Sterling also remains near the one-month low of $1.3464 touched last week.

Andrew Wishart, senior UK economist at Berenberg, says the inflation data still shows few signs of a broader increase in prices that would signal inflation persistence after the energy price shock fades.

BoE outlook and pressure from energy prices

Attention is now turning to the Bank of England's announcement on Thursday, when policymakers are expected to leave interest rates unchanged. Investors are currently pricing in about a 20% chance of a quarter-point increase to 4%, while fully pricing in a hike at the November meeting and expecting further increases in 2027.

A rise in energy prices since the outbreak of the Iran war at the end of February has pushed investors to expect tighter policy from major central banks, including the BoE. Before that conflict, markets had been expecting the BoE to begin cutting rates this year.

Kirstine Kundby-Nielsen, senior FX analyst at Danske Bank, says a soft labour market, limited upward pressure in inflation and contained underlying price growth should help keep a rate increase at bay. She adds that if the BoE adopts a more dovish stance and does not raise rates, the pound could weaken.

Our earlier report on UK inflation rising to 3.1% in August outlined how renewed energy-cost pressures pushed CPI further above the Bank of England’s 2% target ahead of the September policy decision. We noted that with core inflation steady and services inflation elevated, markets increasingly leaned toward a potential rate hike by November, while policymakers weighed whether the energy shock would translate into more persistent price and wage pressures.

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