Dollar Weakness Drives Sterling Strength Amid UK Inflation

The British pound (GBP/USD) has been on the rise lately, but its strength is being driven more by dollar weakness than sterling fundamentals. Despite a strong inflation print from the UK, which saw headline CPI accelerate to 2.9% in July, the pound barely budged.

This tepid response was due in part to the fact that services inflation eased and producer input prices fell sharply, indicating that the increase in headline inflation may be driven by pass-through effects rather than domestically generated price pressure.

The bigger driver of sterling's strength has been the dollar's decline, which has been fueled by a series of soft US data releases, including lower-than-expected retail sales and nonfarm payrolls. The Treasury's announcement that it will increase the size of liquidity support buyback operations for longer-dated nominal coupon securities also contributed to the dollar's weakness.

The market now carries around 55 basis points of Bank of England tightening from a base rate of 3.75%, but private-sector regular pay growth has slowed to 2.8% year over year, its weakest pace since late 2020. This has raised questions about the need for further interest rate hikes.