Sterling extends gains as UK inflation strengthens Bank of England rate hike bets

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Sterling gains on UK inflation

Highlights

UK consumer price inflation rose to 3.5% in September from 3.1% in August, exceeding expectations and fueling November rate hike bets.
Sterling gained 0.1% to $1.339 and 0.2% against the euro to 83.80 pence, marking 17-month and nearly one-month highs respectively.
Money markets almost fully price in a 25-basis-point November rate hike by the Bank of England, with four increases expected by mid-2025.

Inflation data sharpens November policy expectations

As reported by Reuters, UK consumer price inflation rises to 3.5% in the 12 months to September, up from 3.1% in August and above the 3.4% forecast from economists polled by Reuters. The Office for National Statistics says the increase comes as higher energy prices linked to the Iran war gather momentum.

Sterling is last up 0.1% at $1.339, holding near its highest level in about a month. Against the euro, the pound gains 0.2% for a fifth straight session, leaving the single currency at 83.80 pence and pushing sterling to its strongest level versus the euro in 17 months.

Additional labour market data also supports the case for tighter monetary policy. Data released on Tuesday shows British workers record another modest increase in pay growth and points to a small recovery in the jobs market.

Pantheon Macroeconomics says strong growth, stable or falling labour market slack and surging inflation mean the Bank of England's Monetary Policy Committee will raise rates in November. The consultancy also says it expects another increase in February and is close to adding a third move in May, or earlier.

Money market pricing indicates traders are nearly fully factoring in a 25-basis-point rise in November. LSEG data also shows markets currently expect four rate increases by the middle of next year.

Euro weakness and UK budget remain market focus

The pound has gained close to 2% against the euro this month, putting it on course for its strongest monthly performance since May 2023. Sterling is also up almost 1% against the dollar so far this month.

The euro remains under pressure across major currency pairs as traders stay cautious on the single currency. Market sentiment toward the euro is hit by widespread anti-government protests in France and a worsening fiscal outlook that has pushed the country's 10-year borrowing costs towards 24-year highs.

Investors are also looking ahead to British finance minister John Healey's first budget next week. Earlier this month, Healey says the budget will include measures to strengthen the resilience of Britain's economy to the Iran war energy price shock and provide "a bit of breathing space" for the country.

Deutsche Bank economists say the key question for markets is whether a low-key budget does little to damage credibility before bigger decisions on spending, tax and borrowing next year.

Our earlier article on expectations for a Bank of England rate rise in November explained that persistent inflation pressures and stronger UK data were pushing economists toward a 25-basis-point hike to 4.0%. It also noted that while views on follow-up increases were mixed, the inflation outlook—partly influenced by higher energy costs linked to the Iran conflict—was keeping markets focused on the risk of tighter policy.

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