The Pound Sterling is experiencing pressure due to a sharper than expected drop in UK inflation, making a 25 basis point rate cut by the Bank of England likely. Markets are now anticipating a more rapid easing cycle in the coming year.
UK inflation fell to its lowest in eight months, recorded at 3.2% year-on-year in November compared to expectations of 3.6% and the previous month’s 3.5%. Core CPI also decreased to 3.2% year-on-year, against expectations of 3.4%, while services CPI dropped to 4.4% year-on-year, slightly below expectations.
Bank Of England Rate Reduction Expectations
The probability of a cumulative 75 basis point reduction in BOE rates over the next year has increased to 90% from 80%. The Bank of England is expected to lower the policy rate to 3.75%. The Pound is projected to continue underperformance in the currency market.
With UK inflation falling to 3.2%, well below expectations, the Bank of England has a clear path to cut its policy rate tomorrow. We see the market rapidly pricing in a more aggressive easing cycle for 2026. This development puts immediate and sustained pressure on the Pound Sterling.
Our focus should be on positioning for further GBP weakness against currencies backed by more patient central banks. For instance, the US Federal Reserve held its key rate at 4.0% last week and recent data showed US unemployment holding at a low 3.8%, creating a policy divergence that favors shorting GBP/USD. We are looking at buying GBP puts or establishing put spreads to capitalize on this expected decline.
Exploring Interest Rate Derivatives
Beyond the currency market, we are also looking at interest rate derivatives. While the market now anticipates 75 basis points of cuts over the next year, the surprise inflation drop combined with reports of stagnant UK GDP growth in the third quarter of 2025 suggests the BoE may need to act even more decisively. Receiving fixed on Sterling Overnight Index Average (SONIA) swaps appears to be an attractive position.
This environment is reminiscent of the central bank pivots we witnessed back in late 2023, when early signs of disinflation prompted a rapid repricing of rate expectations. One-month risk reversals, which track the demand for bullish versus bearish options, have already turned sharply negative for GBP. This indicates a strong market bias for further downside in the coming weeks.
