USD Bid After U.S. Inflation Surprises to the Upside

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The Dollar strengthened against the Pound, Euro and other major currencies after the release of data that showed U.S. inflation accelerated in December.

U.S. CPI inflation rose 3.4% year-on-year in December, according to the BLS, up from 3.1% in November and surpassing the 3.2% consensus expectation.

Core inflation edged lower to 3.9% y/y in December from 4.0% previously, but this was higher than the consensus expectation for a decline to 3.8%.

The Pound to Dollar exchange rate dipped to 1.2702 in the minutes following the release, a predictable response to the undershoot.

"The more robust inflation data benefited the dollar," says Alex Kuptsikevich, senior market analyst at FxPro. "Purchases are backed by falling chances of the Fed's rate cut cycle starting as early as March. The market now puts the chances of such a move at 67% versus over 90% just over a fortnight ago."

"This should offer some support to the Dollar going forward," says a note from Wagering Advisors following the data release.

Money markets further pared bets for an imminent interest rate cut at the U.S. Federal Reserve, lending some support to U.S. bond yields.

"You ain't getting a March rate cut. It is the kind of print that shouts the Fed does not need to rush to cut this quarter," says Neil Wilson, Chief Market Analyst at Finalto.

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"Disinflation won’t be linear and we think the Fed is going to be rather (perhaps overly) cautious in easing in this kind of environment. It’s going to take way, way longer to get to target," he adds.

The Dollar has started 2024 on a strong footing as the market lowers expectations for the scale of interest rate cuts at the Fed over the coming months in the face of evidence of ongoing strength in the U.S. economy.

This can put a layer of support under the Dollar and frustrate the Pound-Dollar exchange rate's ascent, potentially capping it just above 1.28 for the foreseeable future.

"We believe that there’s still not enough evidence for the central bank to start cutting rates," says Nigel Green, CEO of deVere Group. “With inflation remaining sticky, we expect rates will be higher for longer. We don’t see a policy pivot in sight."

Above: Inflation is still on track to fall towards the Fed's target says ING.

The Dollar fell in the wake of the December Fed meeting after officials effectively condoned the market's increasingly aggressive bets for rate cuts, with the first cut expected as soon as March.

"However, the tight jobs market and today's firmer-than-expected inflation numbers suggest this is unlikely, barring an economic or financial system shock. We continue to think the Fed will prefer to wait until May," says James Knightley, Chief International Economist at ING Bank.

ING says the prospects for consumer price inflation returning to 2% y/y remain good.

"While today's report wasn't as good as it could have been, there are still reasons for optimism on sustained lower inflation rates in 2024. We still see a good chance headline and core CPI to be in the 2-2.5% YoY range by late second quarter," says Knightley.