Another Soft U.S. Inflation Read

"Back in 2021, we saw three consecutive months of relatively low readings of core inflation before it jumped back up. We do not want to be head-faked. I will be looking for the recent improvement in headline and core inflation to continue" - Governor of the Fed Board Christopher Waller.

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The Pound to Dollar exchange rate attempted to rally after the Federal Reserve's (Fed) preferred measure of inflation softened again but Sterling found plentiful willing sellers as the market continued to favour the greenback ahead of next week's interest rate decisions. 

Dollars were sold to the tentative benefit of Sterling and other currencies late on Friday after the Bureau of Economic Analysis said the Core Personal Consumption Expenditures (PCE) Price Index had risen by 0.3% for the month of December but declined from 4.7% to 4.4% in annualised terms.

The overall PCE Price Index rose 0.1% in a year-end outcome that drove the annualised rate down to 5%, from 5.5%, after increased services prices were unable to offset the effect of a -5.1% fall in energy costs. 

Rising prices for transportation led the increase in services sector inflation, the main driver of overall inflation in December, with housing and utilities prices following closely behind inflation of food services and accomodation costs.

"We think it's worth watching the weekly close in GBPUSD, as we may see a double top forming. Our technicals team has flagged decent resistance around 1.2340-1.2450 so let's see if it holds on a weekly basis, and importantly if 1.25 will," says Varshi Karamsetty, a markets analyst at CitiFX.

Above; Pound to Dollar rate shown at 15-minute intervals alongside GBP/CAD and EUR/USD. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.

"CitiFX Strategy says GBP will underperform due to a UK recession and repricing lower of the BoE’s rate path, but their favored expression is short GBP vs CAD via options," Karamsetty writes in a Friday research briefing.

Friday's data confirms the Fed's preferred measure of inflation is following the official consumer price index rate lower but with momentum picking up in some categories, it's not clear how much comfort the bank will take from the data.

More so after Thursday's initial estimate of final quarter GDP beat economist expectations, although many say the report was weaker than it looked and are still forecasting a technical recession for later in the year.

"My expectation of a mild recession beginning in Q2 appears on track. There is the swing to positive real rates, the beginnings of a mild inventory correction, and the “asset crunch” softening growth on into the current quarter," says Steven Blitz, chief U.S. economist at TS Lombard. 

"My 3% forecast for Q4 growth came in on target. Based on the flow of growth through the quarter and how Q4 GDP growth was put together (2/3 coming from inventory and government spending), I am sticking with 1% for Q1 – will have a closer look tomorrow after Dec income data are released," he adds.

Other data out on Friday suggested that consumer sentiment about the economy stabilised in December, even as consumer spending declined, and that pending home sales rose for the first time since May 2022. 

Above; Pound to Dollar rate shown at daily intervals. Click image for closer inspection. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.

Inflation expectations measured by the University of Michigan also declined on Friday in what is likely a welcome development for the Fed.

The Fed is widely expected to lift its interest rate by 25 basis points to 4.75% next Wednesday in what TS Lombard's Blitz says is likely to be its last increase, although for the Pound to Dollar rate, what likely matters most is what Fed says about the prospect of further increases later in the year.

"While it is possible to take a month or three months of data and paint a rosy picture, I caution against doing so. The shorter the trend, the larger the grain of salt when swallowing a story about the future," Governor of the Fed board Christopher Waller told the Council on Foreign Relations last week. 

"Back in 2021, we saw three consecutive months of relatively low readings of core inflation before it jumped back up. We do not want to be head-faked. I will be looking for the recent improvement in headline and core inflation to continue," he added in the speech titled "A Case for Cautious Optimism." 

Governor Waller cited December's increase in the month-on-month rate of inflation as one reason for why "I am still cautious about the inflation outlook and supportive of continued monetary policy tightening," despite recent declines in the annual U.S. inflation rates.

Other on the Federal Open Market Committee (FOMC) have also argued for ongoing increases in interest rates even as markets have bet increasingly that borrowing costs are likely to be cut by year-end, and one risk for Sterling is that this remains the collective view of the FOMC next week.