The UK core Consumer Price Index rose 3.1% year on year in January. This matched market expectations.
Core CPI excludes food and energy prices. The release indicates the annual rate held at 3.1% for the month.
Near Term Market Reaction
With the January core inflation figure landing exactly as expected at 3.1%, we don’t anticipate a sharp, immediate shock to the market. This lack of surprise has already dampened short-term volatility in sterling and gilt futures. For the next few days, this suggests selling near-term options premium might be a viable strategy, as the market digests this on-target data point.
However, the bigger picture remains complicated for the Bank of England, creating opportunities for us. While inflation is cooling, recent data showed UK wage growth for the three months to December 2025 came in at a sticky 4.7%, well above a level consistent with a 2% inflation target. This tension between falling headline inflation and persistent domestic price pressures is the key dynamic to trade.
This reinforces our view that the Bank of England will remain on hold at its next meeting in March. Looking back, they held rates firm throughout 2025 to tame inflation, and they will be hesitant to cut prematurely. Current overnight index swaps are now pricing in only a 40% chance of a rate cut by June 2026, pushing the first fully priced-in cut to August.
For interest rate traders, this means the front end of the UK yield curve is likely to remain elevated and anchored. We see value in positioning for a flatter curve, as near-term rate expectations stay firm while longer-term growth concerns persist. This involves looking at derivatives that profit from the narrowing spread between two-year and ten-year gilt yields.
In the currency markets, this “higher for longer” rate environment should offer a floor for the pound against the dollar and euro. However, with UK GDP growth having been flat in the final quarter of 2025, upside for sterling is also capped. We believe selling GBP volatility through options strategies like short strangles is attractive, capitalizing on a potentially range-bound currency pair in the weeks ahead.
Equity Derivatives Implications
For equity derivatives, the absence of a negative inflation surprise is a modest positive, but the prospect of firm interest rates will limit any major rally in the FTSE 100. We are looking at this as an opportunity to buy some medium-term downside protection. Purchasing put options on the FTSE index dated for the second quarter could be a prudent hedge against the risk of a market downturn if economic weakness begins to overshadow the inflation narrative.
