EUR/GBP ticks lower as rally in UK gilt yields pauses after soft inflation data

• EUR/GBP edges lower as UK gilt yields cool down after soft inflation data for December.
• Traders have raised BoE dovish bets on the back of soft inflation data.
• The ECB is expected to cut interest rates atleast three times this year.

The EUR/GBP pair edges lower to near 0.8440 in Wednesday’s North American session. Five-day rally in the cross that was built on surging yields on United Kingdom (UK) gilts appears to be losing fuel. 30-year UK gilt yields tumble from their more-than-26-year high of 5.47% to 5.38% after the release of the soft UK Consumer Price Index (CPI) report for December, which led to a recovery move in the Pound Sterling (GBP).

The UK CPI report showed that the core inflation – which excludes volatile items, such as food, energy, oil, and tobacco – grew by 3.2%, slower than estimates of 3.4% and the former reading of 3.5%. Annual headline inflation surprisingly decelerated to 2.5% from 2.6% in November. Economists expected the underlying inflation data to have accelerated to 2.7%.

Signs of cooling price pressures have prompted expectations for the Bank of England (BoE) to cut interest rates in February’s policy meeting. Markets currently see an 84% chance of the BoE cutting rates by 25 basis points (bps) on February 6, compared to a 62% chance at Tuesday's close.

Technically, cooling inflationary pressures weigh on the currency. However, the Pound Sterling rebounded as it was declining sharply for a week due to surging gilt yields. Investors were dumping government bonds as they lacked confidence in the UK economic outlook due to stubborn price pressures and a likely trade war with the United States (US), given that President-elect Donald Trump will raise import tariffs sharply. This scenario would heavily weigh on the UK’s exports.

Investors expected a sharp rise in the UK government’s borrowing costs would force the administration to cut spending heavily.

Meanwhile, the Euro (EUR) broadly underperforms on Wednesday as European Central Bank (ECB) officials are comfortable with market expectations for the central bank to deliver atleast three interest rate cuts this year. Trades have priced in a significant number of ECB interest rate cuts as the Eurozone inflation has broadly remained under control.

ECB policymaker and Governor of the Bank of France François Villeroy de Galhau said in Wednesday’s European session, "It makes sense for interest rates to reach 2% by the summer" as we have practically won the "battle against inflation".