January 15, 2025

“The FX market is being driven by inflation and speculation around Trump’s trade policy this week. US and UK inflation have come in soft so far, though the pound’s unusual dynamics this month mean that it has held on. US CPI is the main event of the week this afternoon.”

Tim Hallinan – Trading Director

USD

The dollar had a softer day yesterday and shed the remaining strength gained from Friday’s payrolls figure, as markets welcomed the prospect of a gradual implementation of tariffs and a weaker-than-expected PPI inflation report.  Unlike the Washington Post article about watered down tariff plans last week, which Trump vehemently denied on Truth Social, the Bloomberg report about enacting tariffs in 2-5% increments appears to have had more persistence. Tariffs are evidently front of mind for the President-elect, who declared on social media yesterday that he would create an ‘External Revenue Service’ to collect import duties. Meanwhile, inflation concerns eased slightly after headline PPI came in at 0.2% – half the consensus – and core landed at 0.0% flat. The caveat to the good news was that the PCE-relevant components of the index remained relatively strong – remember that core PCE is the Fed’s preferred measure of inflation.

The focus moves on to the CPI inflation figure today, and that will be the major clue for markets last week. The figure to look for on the headlines is 2.9%, although for markets the key concern is that core CPI holds at 0.3% for the fifth month in a row, which annualises out at a rate close to 4%. The combination of the sticky inflation outlook, strong activity figures, and Trump’s protectionist agenda explains why only one cut is expected from the Federal Reserve this year.

GBP

Sterling’s recent unusual reaction function to yields has been on full display this morning, having whipsawed as traders try to pick the right direction following a milder-than-expected inflation report this morning. Inflation unexpectedly dropped from 2.6% to 2.5%, driven by a sharp decrease in services inflation from 5.0% to 4.4%. That is some welcome relief for policymakers at the Bank of England, where the implied probability for a February rate cut has risen to 87%. Typically, a developed market currency responds negatively to weaker inflation, because it has a knock-on effect on yields, which fall lower on the prospect of lower rates in the future. Over the past week, however, the relationship has inverted for sterling, as higher yields squeeze the Treasury’s fiscal headroom and increase the chances that Reeves must deliver some more tax hikes or – much more likely – some spending cuts in the Spring Budget to offset the increase in the interest bill. At the time of writing, the pound is almost flat following the release. Today, we get a second look at some rhetoric from the BoE’s Taylor and the next piece of data is November GDP tomorrow morning, where 0.2% growth is expected.

EUR

The euro has climbed over 1% since it hit a 26-month low on Monday morning. It remains a dollar story, with the softer tariff news and US PPI providing the fuel needed for a short rebound. The data calendar remains relatively quiet for the eurozone, but we do get some speeches from the ECB today ahead of the next decision in two weeks’ time. Guindos and Villeroy have provided some dovish commentary this morning and both have argued that disinflation is well on track, with the latter calling for rates to fall to 2% by the summer – something the market is not yet pricing until closer to the end of the year.

Markets

Asset markets largely drifted sideways yesterday as traders awaited today’s US CPI print. European stocks inched slightly higher as the prospect of watered down tariff implementation boosted sentiment – particularly in Germany, where the automakers made some gains and helped to lift the DAX by 0.7%.

Main Economic Events (All Times CET)

8:00am: UK CPI
2:30pm: US CPI

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