GBP/USD Rallies, Helped by Key U.S. Inflation Gauge

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The Pound to Dollar exchange rate looks set to end the week on a solid footing, aided in part by the release of a much-watched inflation gauge that undershot expectations.

The Core Personal Consumption Expenditures (PCE) index read at 2.9% year-on-year in December, which is down sharply from November's 3.2% and below consensus expectations for 3.0%.

The core PCE deflator remains the Federal Reserve's preferred inflation measure and could factor into when the first rate of the hiking cycle falls.

"The faster-than-expected drop of core PCE inflation in recent months in particular has encouraged rates markets to price in a very aggressive easing cycle from the Fed," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Marinov says the sub-3.0% could suggest that the Federal Reserve should start debating rate cuts before too long.

The PCE index rose 0.17% month-on-month in December, making for the sixth month in the last seven where monthly inflation has printed at a rate equal to or below the Fed's 2% target: the six-month annualised reading now stands at 1.9%, and on a three-month annualised basis, the figure is 1.5%.

The softer Dollar in the wake of the print suggests markets are inclined to believe the Fed will be more comfortable with the idea of interest rate cuts and is set to deliver up to six cuts in 2024.

The Pound to Dollar exchange rate has risen a quarter of a per cent to quoted at 1.2756, taking the weekly advance to 0.40%.

Above: GBPUSD at weekly intervals, showing a collapse in volatility. Track GBP/EUR with your own custom rate alerts. Set Up Here

To be sure, we have now witnessed some incredibly calm trading conditions in Pound-Dollar: this is the sixth consecutive week that we have seen a weekly close above 1.2695 but below 1.2750.

This apparent easy-going nature of Pound-Dollar could be challenged next week as both the Federal Reserve and Bank of England deliver their latest policy decision and guidance updates.

Both will be keen to underline the belief that it is too soon to discuss interest rate cuts while simultaneously hinting that the time for such discussions is approaching.

Should the message land with markets, then Pound-Dollar can look forward to further limited volatility. But one only needs to look at Thursday's ECB event for a reminder that central bankers walk a fine line when trying to guide markets and any slip-ups can deliver decent FX volatility.