GBP to USD rate up to 1.3040U.S. inflation hotBut, not as hot as expected

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There was a notable foreign exchange market reaction to the release of U.S. inflation data that showed prices rose sharply in March, keeping alive expectations for a series of hefty Federal Reserve rate hikes.

But the market's reaction suggests inflation data were not quite hot as might have been expected and the Dollar was sold as a result.

The GBP to USD exchange rate rose to 1.3040 after U.S. core CPI inflation rose 0.3% month-on-month in March, down on the 0.5% printed in February and underwhelming against the 0.5% the market was looking for.

Above: GBP/USD at five minute intervals showing the lift in the wake of the inflation data release.

In fact, "if you strip out shelter monthly core CPI rose +0.2%," says Viraj Patel, an analyst at Vanda Research.

Annual core CPI grew 6.5%, higher than February's 6.4%, but below the 6.6% the market expected.

Headline CPI inflation grew 8.5% in March, ahead of expectations for 8.4% and the previous month's 7.9%.

The foreign exchange market's reaction suggests investors have certainly placed a greater emphasis on the core inflation component, given the headline figure is heavily influenced by global energy prices.

Patel says the figures could prove to be "a game-changer for how people think about the monthly run rate and a re-think about whether breadth of price increases can continue in '22".

The GBP to USD exchange rate rose to 1.3040 in the wake of the data having been as low as 1.2995 prior. The EUR to USD rate rose to 1.0888 having been as low as 1.0851. The Dollar index - a broad measure of Dollar strength according to a basket of USD exchange rates - fell from 100.19 to 99.84. (Set your FX rate alert here).

The Federal Reserve is expected to respond to rising inflation by hiking interest rates by up to 220 basis points in 2022, with two successive 50 bp hikes expected in the upcoming two meetings alone.

But, should inflation begin to decelerate faster than expected these expectations could moderate.

The Dollar rally could moderate too, as a result.

"Unless the oil price rises sharply again, this could be the peak," says Christoph Balz, an economist with Commerzbank. "Even in this case, however, inflation is not expected to fall quickly. The Fed thus remains under pressure".

The headline inflation data show the majority of the price pressures facing American's has its roots in global factors related to rising oil and commodity prices.

"Otherwise, inflationary pressure tended to ease somewhat," says Balz.

Used car prices fell by 3.8%, as one of the key drivers of inflation in 2021 now starts to offer a material drag.

Goods prices, outside energy and food, fell by 0.4%.

"Whether the inflation rate peaked in March depends above all on the further development of oil and gasoline prices. If the oil price remains at the current level of around $100 per barrel of Brent and does not rise again, March probably was the high in the inflation rate," says Balz.

If inflation does start coming down expect the peak in U.S. Federal Reserve hiking expectations to be at hand.

From a currency market perspective, this could imply the Dollar is nearing its top.