Chart of the Week: UK and US monetary policy expectations diverge

UK inflation declined by more than expected last month, triggering a sharp fall in sterling as investors reduced their bets on further rate hikes by the Bank of England. Headline inflation for January was 10.1% year-on-year, 0.2 percentage points below market expectations. More importantly for rate setters, stickier core inflation was 0.4 percentage points lower than expected at 5.8% year-on-year, the second largest downside surprise since the series began in 2015. The Monetary Policy Committee hinted at its February meeting that it believes it is close to the end of its hiking cycle. The accompanying Monetary Policy Report showed inflation falling well below its 2 per cent target if rates were raised in line with market expectations, likely indicating that the Committee believed the market profile for Bank Rate was too steep. In contrast to the UK, markets are pricing a considerably higher US terminal rate than at the start of the year as economic activity continues to surprise to the upside. Headline and core inflation also declined in the US in January but by marginally less than expected. Driven by the widening expected interest rate differentials, sterling fell 2% against the dollar following the two inflation data releases.

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