GBP/USD retreats after US inflation data

• GBP/USD falls after the release of US CPI data, which shows a drop in headline inflation but stubbornly high core inflation.
• The data suggests the Fed will take a cautious approach to easing and will likely cut rates by 25 rather than 50 bps.
• GBP is under pressure after UK GDP was flat in July and missed estimates.

GBP/USD is trading modestly lower at 1.3060 on Wednesday following the release of US inflation data, leading to an appreciation in the US Dollar (USD) amid prospects of a more measured approach to easing by the Federal Reserve (Fed), while the British Pound (GBP) is losing ground following the release of flat economic growth data.

U.S. consumer prices rose roughly in line with expectations, although the annual change in the headline Consumer Price Index (CPI) missed economists’ expectations by one point, coming in at 2.5% instead of the 2.6% expected, according to data from the U.S. Bureau of Labor Statistics on Wednesday.

Core CPI (excluding food and energy) also rose as expected, but monthly core CPI rose 0.3% more than expected, suggesting some persistence in underlying prices, which analysts say stems from persistent housing inflation.

Although the data was mixed, it showed that inflation remains high enough that the Fed does not want to drastically cut interest rates at its next meeting, but instead take a more measured approach. The odds of a “jumbo” 50 basis point (bp) cut at the Fed’s September 17-18 meeting fell to 15% after the release, from around 27% beforehand. A 25 bp (0.25%) cut remains fully priced in.

“Overall, inflation appears to have been successfully contained, but, with housing inflation still refusing to moderate as quickly as expected, it has not been fully defeated. In those circumstances, we expect the Fed to take a measured approach to reducing interest rates,” commented Paul Ashworth, Chief North American Economist at Capital Economics.

With the chances of a larger US interest rate cut diminishing, the USD strengthened (GBP/USD fell), as expectations of relatively higher interest rates are usually favorable for a currency because they lead to higher foreign capital inflows.

Meanwhile, UK data painted a negative picture of the country’s economic outlook, weighing on Cable. The Gross Domestic Product (GDP) growth rate in July failed to rise (0.0%) when economists had expected a 0.2% increase, according to data from the Office for National Statistics (ONS) on Wednesday. Industrial and manufacturing output both came in below expectations, with the former falling 0.8% month-on-month and 1.2% year-on-year in July, and the latter declining 1.0% and 1.3% respectively.