The lower than expected inflation data will undermine Sterling with increased expectations of a further near-term interest rate cut

Sterling weakened to lows near 2.01 against the dollar on Monday before pushing back above 2.02 in New York. Sterling was holding just below 2.02 in early Europe on Tuesday while the advance against the euro stalled close to 0.7120. Sterling then dipped sharply after the inflation data with a retreat to 2.0125 against the dollar.

UK consumer prices rose 0.3% in November with the annual rate unchanged at 2.1% compared with expectations of a small rise to 2.2%. The core inflation rate also moved lower to 1.4% from 1.5%, contrary to expectations of an increase to 1.6%.

The Bank of England will still be uneasy over inflation trends, especially as the RPI reading was higher than expected at 4.3%, but the drop in core CPI will reinforce expectations that the central bank will be able to cut interest rates again early in 2008.

Unease over UK economic trends, allied with persistent risk aversion, will continue to curb Sterling demand with a risk that longer-term institutional Sterling positions will be liquidated.