UK core Consumer Price Index (CPI) rose 3.1% year on year in January, in line with market expectations.
Core CPI strips out food and energy prices. The release shows the annual rate stayed at 3.1% for the month.
Near Term Market Reaction
Because January core inflation came in exactly as expected at 3.1%, we do not expect an immediate market shock. The lack of surprise has already reduced short-term volatility in sterling and gilt futures. Over the next few days, this could make selling near-term options premium an appealing strategy as the market absorbs this in-line data.
Still, the bigger picture for the Bank of England remains complex, which creates opportunities. Inflation is cooling, but wage growth is still high. Recent data showed UK wage growth for the three months to December 2025 was 4.7%, well above a level consistent with a 2% inflation target. This gap between easing inflation and stubborn domestic price pressure is the main theme to trade.
This supports our view that the Bank of England will keep rates unchanged at its March meeting. The Bank held rates steady through 2025 to bring inflation down, and it is unlikely to cut too soon. Overnight index swaps now imply only a 40% chance of a cut by June 2026, with the first fully priced cut pushed out to August.
For rates traders, this suggests the front end of the UK yield curve should stay high and well supported. We see value in positioning for a flatter curve: near-term rate expectations may remain firm, while longer-term growth worries continue. This points to derivatives that benefit if the spread between two-year and ten-year gilt yields narrows.
In FX, a “higher for longer” rate backdrop should help put a floor under sterling versus the dollar and the euro. But with UK GDP flat in Q4 2025, sterling’s upside also looks limited. We like selling GBP volatility through options strategies such as short strangles, aiming to benefit from potentially range-bound trading in the weeks ahead.
Equity Derivatives Implications
For equity derivatives, the lack of an inflation downside surprise is mildly positive. However, the outlook for firm interest rates may limit any strong FTSE 100 rally. We see this as a chance to add medium-term downside protection. Buying FTSE index put options expiring in the second quarter could be a sensible hedge if weakening growth starts to dominate the inflation story.
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