Deutsche Bank said January UK inflation data is likely to be challenging for the Bank of England, as services CPI and core CPI came in above the Monetary Policy Committee\u2019s projections. Headline CPI was almost 0.1 percentage points higher than expected, while services CPI was about 0.25 percentage points higher at the start of the year.<\/p>\n
The report said price momentum eased, but not as quickly as the MPC had forecast. It added that this makes a March rate cut less certain.<\/p>\n
Deutsche Bank still forecast two rate cuts, scheduled for March and June. It said stronger price pressures could lead to a slower pace of cuts, but with a larger total reduction over time.<\/p>\n
The note also referred to a weakening labour market. It said model-based measures of inflation expectations point to further declines in the coming months.<\/p>\n
The January inflation numbers will make the Bank of England uncomfortable. We saw services inflation come in hotter than expected at 5.5%, which is nearly a quarter-point higher than the MPC had pencilled in. This complicates the path forward and puts the idea of an imminent rate cut into question.<\/p>\n
This has already forced a repricing in the rates market. Looking at overnight index swaps, the implied probability of a March rate cut has dropped from over 75% just last week to around 40% today. For traders, this means the risk is now that the Bank of England holds rates steady for longer than previously anticipated.<\/p>\n
However, we must balance this against a cooling labour market, with the latest data showing unemployment ticking up to 4.5% and wage growth slowing. This tug-of-war between sticky inflation and a weaker economy increases uncertainty, suggesting volatility in short-term interest rate futures could rise. This environment may favour options strategies that profit from price swings rather than a specific direction.<\/p>\n
This delayed rate cut expectation is supportive for the pound, especially against currencies where central banks are more clearly signalling cuts. We saw throughout 2025 how sensitive sterling was to shifting interest rate differentials. A similar pattern could emerge now, favouring long GBP positions.<\/p>\n
The overall view is skewing towards a slower start to the easing cycle, but one that may ultimately be deeper. This could lead to a flattening of the yield curve, where short-term rates remain elevated but longer-term rates price in more significant cuts down the road. This reflects the difficult trade-off the MPC is now facing.<\/p>\n
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