The Pound Sterling is facing pressure due to a larger-than-expected drop in UK inflation. This makes it likely that the Bank of England will cut rates by 25 basis points. Markets now expect a quicker easing cycle in the next year. UK inflation fell to its lowest level in eight months, recorded at 3.2% year-on-year in November. This is lower than the expected 3.6% and the previous month’s figure of 3.5%. Core CPI also dropped to 3.2% year-on-year, below the forecast of 3.4%. The services CPI decreased to 4.4% year-on-year, slightly missing expectations.

Bank Of England Rate Reduction Expectations

The chance of a total 75 basis point cut in BOE rates over the next year has risen to 90% from 80%. The Bank of England is likely to lower the policy rate to 3.75%. The Pound is expected to continue underperforming in the currency market. With inflation at 3.2%—well under expectations—the Bank of England is set to cut its policy rate soon. The market is quickly pricing in a more aggressive easing strategy for 2026, putting pressure on the Pound Sterling. We should prepare for further GBP weakness against currencies tied to more patient central banks. For example, the US Federal Reserve kept its key rate at 4.0% last week, with US unemployment steady at a low 3.8%. This creates a policy gap that favors shorting GBP/USD. We are considering buying GBP puts or setting up put spreads to profit from this expected decline.

Exploring Interest Rate Derivatives

Besides the currency market, we are also examining interest rate derivatives. While the market expects 75 basis points of cuts in the next year, the surprising inflation drop, along with reports of stagnant UK GDP growth in the third quarter of 2025, suggests that the BoE may need to act more decisively. Taking a fixed position on Sterling Overnight Index Average (SONIA) swaps seems appealing. This situation is similar to the central bank shifts observed in late 2023, when early signs of disinflation led to a rapid adjustment of rate expectations. One-month risk reversals, which measure demand for bullish versus bearish options, have already turned sharply negative for GBP. This indicates a strong market expectation for further declines in the upcoming weeks. Create your live VT Markets account and start trading now.

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