Should you buy or sell the British pound amid inflation coming down?

This week it is all about inflation data. Yesterday, financial market participants learned that yearly inflation in the United States reached 6.4%, a tad higher than expectations, as written here.

Inflation has created excess volatility in financial markets, and this week is no different. The US dollar and the stock market were all over the place yesterday, and today it was the time to see the changes in prices of goods and services in the United Kingdom.

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The British pound performed differently against its peers in the last several months.

For example, it gained against the US dollar as the greenback weakened across the board. However, it lost against the euro, as investors find the common currency more appealing in 2023.

But the pound did move in one direction and one direction only at today’s inflation report. That is, to the downside.

Core inflation unexpectedly declined in the United Kingdom

Inflation in the United Kingdom remains elevated. Some causes of concern are that it is still five times higher than the Bank of England’s target or is still in double-digit territory. For January, the yearly CPY was 10.1%.

But the good news is that core inflation is slowing down and doing so fast. In particular, core services declined abruptly as price pressures eased in restaurants and cafes.

It makes sense to divide the core inflation into services and goods because the UK economy is service-based. Core services inflation excludes airfares, education, and package holidays, while core goods inflation excludes food, energy, alcohol, and tobacco. These product and service categories are considered too volatile; thus, like other central banks, the Bank of England prefers the core measures.  

How did the British pound react?

The pound was sold across the FX dashboard. The slowdown in core inflation means that the Bank of England is on the right track with its tightening cycle.

But it also means that the central bank might think it is wise to wait and see the effects of its tightening policy before hiking the bank rate again. Fear of overtightening might stop the Bank of England from hiking; thus, the pound was sold across the dashboard.

Summing up, inflation comes down in the United Kingdom, taking the pound down with it too.