Sterling drops before Fed policy meeting, after UK inflation data

By Stefano Rebaudo

(Reuters) - Sterling fell versus the dollar before the Federal Reserve's policy meeting later on Wednesday, which could suggest a less aggressive monetary easing path in the U.S., while British inflation figures were in line with analyst expectations.

Consumer prices rose by an annual 2.6% in November, although services inflation held at 5.0%.

Money market bets on the Bank of England interest rate outlook were roughly unchanged, with 57 basis points (bps) of monetary easing expected by the end of 2025 from 55 bps just before the release of the inflation figures. [IRPR]

Front-end UK rates were softer, with 2-year gilt yields down 3 bps to 4.41%. The 10-year yields were at 4.51%, not far from 4.594%, their highest since October 2008.

"Today's data will only reinforce the Monetary Policy Committee's (MPC) message of patience and gradualism," said Sanjay Raja, chief UK economist at Deutsche Bank, arguing the MPC "is some way away from declaring victory on inflation."

"Price pressures are resurfacing again – with employers likely to start ramping up prices at the start of the year to account for the employer National Insurance Contributions' (NIC) increase," he added.

The pound softened against the euro, with the single currency up 0.23% to 82.70 pence. The euro hit 82.51 pence last week, its lowest since March 2022.

Investors still expect the pound to be firm as the yield divergence with the euro area will be significant.

While markets price around 55 bps of cut by the BoE in 2025, they discount a European Central Bank deposit rate at 1.8% in December next year from the current 3%.

Analysts also flagged that recent data showing an acceleration of UK wage growth offered a reason for hawks to get louder in the MPC. The rise was all in the private sector, where pay trends are more linked to economic trends.

Sterling dipped 0.2% to $1.2684 versus the dollar.

"The BoE policy outlook is muddled by weaker evidence that the NIC hike will also be inflationary," said Shaan Raithatha, senior economist at Vanguard.

British companies have flagged an increase of 1.1 billion pounds in labour costs related to a rise in employers' social security contributions and minimum wages following Finance Minister Rachel Reeves' maiden budget in October.

(Reporting by Stefano Rebaudo. Editing by Mark Potter)