Pound to Dollar Hits 3-week Low on Uptick in Core U.S. Inflation

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The Dollar was stronger after U.S. inflation beat expectations in August, with the important core CPI inflation reading hitting 0.3% m/m, beating consensus expectations of 0.2%.

The Pound to Dollar exchange rate fell to a 3–week low at 1.3047 after the probability of a 50 basis point Federal Reserve interest rate cut next week fell to 15% vs. 29% pre-US the inflation release.

"The dollar is trading a touch stronger this afternoon as the August US inflation report appears to have effectively ruled out the possibility of a jumbo interest rate cut from the Federal Reserve this month," says Matthew Ryan, Head of Market Strategy at global financial services firm Ebury.

However, Dollar exchange rates should see limited upside as the rest of the inflation report made for mild reading. The three-month annualised core CPI rate now sits close to the Fed's target at 2.1% as of August.

Headline CPI inflation came in at 0.2% m/m in July, matching forecasters predictions, as did the year-on-year rate 2.5%. Core inflation was unchanged at 3.2% year-on-year.

The direction of travel in inflation remains consistent with the Fed achieving its goals of bringing inflation sustainably to target, meaning an interest rate cut next month is fixed in.

"Overall, inflation appears to have been successfully tamed but, with housing inflation still refusing to moderate as quickly as hoped, it hasn’t been completely vanquished. Under those circumstances, we expect the Fed to take a measured approach to cutting interest rates," says Paul Ashworth, Chief North America Economist at Capital Economics.

The shelter component of core inflation is where the stickiness remains, coming in at 0.5% m/m. But the Fed can live with this as most components in the inflation basket continue to see disinflation.

"Inflation momentum is still in very good shape and the progress seen over the past year makes us confident that inflation is headed toward target even if the last mile for shelter disinflation is somewhat bumpy. The Fed’s focus now is on whether the jobs market is “normalising” or “deteriorating”, and that means inflation reports are taking a back seat to labor market data," says Ali Jaffery, an economist at at CIBC Economics.

The moderate foreign exchange market response is testament to the lessening importance of inflation to the Fed and USD strength could be limited as a result, particularly given the close proximity of the Fed decision one week today.

“We think that the Fed will strike a dovish note in its communications following the September meeting, indicating to markets that the cooling in the US labour market has accelerated, and that an aggressive pace of cuts may be required in order to support it," says Ebury's Ryan.

If this is the case, the Dollar can potentially weaken.