Sterling's Weakness Reflects Inflation Progress and Labour Market Concerns Ahead of BoE Decision

The Pound Sterling has experienced notable weakness this week, with the currency correcting sharply to approximately 1.3340 against the US Dollar—representing a drop of over 0.5% during Wednesday’s European trading session. For context, this current valuation means that 34 dollars in pounds equates to roughly £25.35, illustrating how exchange rate fluctuations directly impact cross-border financial conversions. This pullback follows what appeared to be a two-month peak above 1.3450 just the previous trading day, signaling a swift reversal in sentiment.

The Catalyst: Better-Than-Expected Disinflation

The primary driver behind Sterling’s recent retreat lies in the latest UK inflation figures released on Wednesday. The Office for National Statistics unveiled that headline Consumer Price Index growth decelerated to 3.2% on an annualized basis—a figure that undershot economist projections of 3.5% and proved considerably softer than October’s reading of 3.6%.

This marks the second consecutive month of decelerating headline price pressures, strengthening the narrative that inflationary momentum in the UK economy is genuinely easing toward the Bank of England’s 2% target. The month-on-month headline CPI actually contracted by 0.2%, defying expectations for a flat reading following October’s 0.4% increase.

Core inflation—stripped of volatile food, energy, alcohol, and tobacco components—also came in below consensus at 3.2%, compared to the anticipated 3.4% and the previous month’s 3.4% print. Most notably for BoE policymakers, services sector inflation, which receives heightened scrutiny from central bank officials, cooled to 4.4% from 4.5% previously.

Labour Market Deterioration Compounds the Picture

Running parallel to these favorable inflation developments is an emerging weakness in the UK employment landscape. Recent data covering the three-month period ending in October painted a concerning picture. The ILO Unemployment Rate climbed to 5.1%—the highest level recorded in nearly five years—exceeding analyst expectations and raising questions about labour market resilience heading into 2024.

This combination of moderating inflation alongside deteriorating employment conditions has crystallized market expectations for an interest rate reduction by the BoE when it convenes for its monetary policy decision on Thursday.

The Dollar’s Paradoxical Recovery

Despite apparent headwinds facing the US economy, the Dollar has staged a meaningful recovery. The US Dollar Index, which measures the Greenback’s performance against a basket of six major currency counterparts, climbed 0.4% to trade near 98.60 on Wednesday, bouncing emphatically from a fresh 10-week trough near 98.00 registered on Tuesday.

This rally emerged despite mixed US labour market signals. November’s Nonfarm Payrolls report revealed that the Unemployment Rate rose to 4.6%, marking the highest reading since September 2021. More concerning, job creation decelerated dramatically, with the economy adding merely 64,000 positions in November after losing 105,000 in October—a performance that ordinarily would trigger dovish monetary policy expectations.

Market participants and Fed officials have attributed this apparent softness to distortions stemming from the historically protracted US government shutdown that overlapped with the survey period. Consequently, the anticipated cascade of rate cut expectations has not materialized with particular force. The CME FedWatch tool continues to price in a held Federal Funds rate within the 3.50%-3.75% corridor when policymakers reconvene in January.

What Markets Await Next

Investor attention will sharpen considerably on Thursday when the November Consumer Price Index for the United States reaches public domain. This inflation reading holds outsized importance given explicit Federal Reserve communications indicating that additional rate cuts could exacerbate already-elevated price pressures, which have persistently exceeded the 2% target.

Recent commentary from Federal Reserve officials underscores this tension. Atlanta Federal Reserve President Raphael Bostic recently articulated concerns about prematurely loosening monetary conditions, cautioning that such moves “risk exacerbating already elevated inflation and untethering the inflation expectations of businesses and consumers.”

Technical Perspective: Sterling Maintains Constructive Bias Despite Pullback

From a technical standpoint, GBP/USD has retreated to 1.3340, yet the pair’s intermediate-term trajectory retains an upward inclination. Price stability above the 20-day Exponential Moving Average (currently positioned at 1.3305) continues to support this constructive bias, despite recent weakness.

The 14-day Relative Strength Index has declined to 56 following its inability to breach overbought thresholds, hinting at potential bearish exhaustion signals. Using the distance between the recent high near 1.3791 and the multi-week low around 1.3008, the 50% Fibonacci retracement at 1.3399 represents the immediate resistance hurdle to overcome.

Should Sterling fail to sustain a daily close above 1.3307—coinciding with the 38.2% Fibonacci level—momentum could deteriorate further, potentially directing price toward the 23.6% retracement around 1.3200. Conversely, sustained acceptance above Tuesday’s high of 1.3456 would potentially unlock the psychological barrier at 1.3500.

Understanding Sterling’s Market Dynamics

The Pound Sterling carries the distinction of being the world’s most venerable currency (originating in 886 AD) and functions as the United Kingdom’s official medium of exchange. In global foreign exchange markets, it ranks fourth in trading volume, commanding approximately 12% of all transactions and averaging roughly $630 billion in daily turnover based on 2022 benchmarks.

The primary GBP/USD pairing—colloquially termed “Cable”—represents 11% of forex activity. Secondary pairings include GBP/JPY (the “Dragon,” accounting for 3% of volumes) and EUR/GBP (comprising 2%).

The Bank of England, which issues Sterling, exercises supreme influence over the currency through monetary policy implementation. The BoE’s foundational mandate centers on achieving “price stability,” defined as sustaining inflation near 2%. Interest rate adjustments represent the institution’s primary policy instrument. Rate increases make credit more expensive and typically strengthen Sterling by enhancing the UK’s appeal to international investors. Conversely, rate reductions cheapen borrowing costs and generally weigh on the currency.

Broader economic data—encompassing GDP figures, Manufacturing and Services Purchasing Managers’ Indices, employment statistics, and trade balances—similarly moves Sterling valuations. Robust economic performance typically supports the currency through dual channels: increased foreign investment inflows and elevated probability of future rate increases. The Trade Balance indicator, measuring export earnings relative to import expenditures, influences Sterling through the mechanism of demand-driven currency flows when export competitiveness shifts.