GBP/USD advances towards 1.3650 irrespective of political risks, as hot CPI boosts BoE tightening calls

• With the US dollar taking a breather on Wednesday after Tuesday’s gains, GBP/USD has recovered back above 1.3600.
• Sterling remains unfazed by political uncertainty, though did derive some support from hot inflation figures which boosted BoE tightening calls.

Despite growing political uncertainty as momentum builds towards a vote of no-confidence within the UK Conservative Party that has the potential to oust UK PM Boris Johnson from the top spot, sterling has been a beneficiary of recent USD weakness. The buck is taking a breather on Wednesday after hitting one-week highs on Tuesday on hawkish Fed bets and widening rate differentials irrespective of weak NY Fed manufacturing survey data, enabling GBP/USD to recover back above 1.3600. At current levels near 1.3640, the pair trades about 0.6% above Asia Pacific session lows and nearly 0.4% higher on the day and is eyeing a test of resistance at 1.3650.

Sterling has been getting independent bullish impetus from another inflation surprise on Wednesday plus confirmation from PM Johnson that “Plan B” Covid-19 restrictions will end next week, as expected. In terms GBP’s reluctance to reflect the risk that Johnson is unseated from the top spot, traders seem to be reasoning that even if the UK PM does go, his likely replacement wouldn’t herald a major economic policy shift.

Turning to Wednesday’s inflation data; headline Consumer Price Inflation hit 5.4% YoY in December, above the expected 5.2%, while core inflation surprisingly rose to 4.2% YoY versus expectations for a drop to 3.9% from 4.0% in November. Traders said the data boosted the likelihood that the BoE hikes rates at its February 3 meeting and UK money markets on Wednesday are impling a 90% likelihood of a 25bps rate hike to 0.5% the week after next. Its also likely that PM Johnson’s as expected confirmation on Wednesday that “Plan B” Covid-19 restrictions will be eased as planned next week will strengthen the BoE’s conviction that the economic impact of the variant will be short-lived.

“The Bank of England was already feeling uncomfortable about its monetary policy stance” one analyst at JP Morgan told Reuters. “Today's upside surprises to both the headline and core inflation readings will certainly not have helped,” the analyst. “The strength of the labour market will give the Bank of England the confidence to continue to remove support for the economy as it looks to get a better handle on inflation” they continued.