Sterling set for sharp one-week drop on UK inflation cooling

LONDON: Sterling continued its slide against the euro and dollar on Thursday as the UK's declining inflation pulled back market expectations of further aggressive rate hikes from the Bank of England (BoE).

Against the euro, sterling fell 0.3% to 86.84 pence, heading towards the two-month low it touched on Wednesday. It was set for its biggest on-week drop since February 2. The Sterling was last down 0.2% against the dollar at $1.2914, set for its fifth consecutive daily drop against the greenback, after falling 0.74% on Wednesday.

Data showed on Wednesday that British annual consumer price inflation fell to a much lower than expected 7.9% in June. Economists polled by Reuters had forecast the CPI rate in the 12 months to June would drop to 8.2% from May's 8.7%. Money markets lowered their expectations for BoE rate hikes, with the prospect of UK rates rising above 6% now likely off the table.

Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets, said he expects the sterling to remain above the lows of $1.2867 hit on Wednesday. "Rates are now barely expected to exceed 5.75%, this compares with assumptions of rates exceeding 6.50% two weeks ago," Stretch said. But "we would expect ongoing rate support to maintain a degree of sterling support," he adds.

The UK still has the highest inflation of the G7. In the United States, headline consumer price pressures are running at a rate of just 3%, while euro zone inflation is at 5%. Wholesale energy prices have fallen sharply this year, which has offered consumers and businesses some respite, but mortgage rates are rising fast and grocery inflation is still in double digits.

BoE Deputy Governor Dave Ramsden said inflation still showed risks of longer-term stickiness.