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The Pound to Dollar exchange rate dropped below 1.26 after U.S. inflation beat expectations across the board when released on Tuesday.

Headline CPI inflation rose 3.1% year-on-year in January, said the BLS, down from 3.4% but beating expectations for 2.9%.

This after the month-on-month change increased to 0.3% from 0.2%, which was also above expectations for 0.2%.

Core CPI inflation - a reading particularly relevant to the Federal Reserve's deliberations on when to cut interest rates - rose to 0.4% m/m from 0.3%. Core CPI read at 3.9% y/y, which was unchanged in December but well above consensus expectations for 3.7%.

"There won’t be high fives at the FOMC’s data briefing on today's release. We expect the Fed will be more comfortable easing in the second half of this year," says Ali Jaffery, an economist at CIBC Capital Markets.

The across-the-board beat on expectations signalled to financial markets to further lower expectations for the amount of rate cuts to come from the Fed in 2024.

U.S. bond yields firmed accordingly and the Dollar was bid:

The Pound to Dollar exchange rate had been flying high ahead of the release courtesy of strong UK wage data but promptly gave back those gains to go back below 1.26.

But it is against other currencies where the Dollar is looking more commanding, with the Yen and Euro down by 0.36% and 0.50% respectively.

"Some drama in today's above consensus January CPI report," says Jaffery. "Today’s report shows that Powell's desire to get a bit more disinflation out of services is not happening yet."

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Seema Shah, Chief Global Strategist at Principal Asset Management, explains the final mile towards the Fed’s 2% target was always going to be slow, erratic, and frustrating.

"Today’s data is not what markets or the Fed would have liked to see, but it’s important not to overreact and jump to the assumption that an inflationary resurgence is developing," she cautions.

Shah points out that although inflation has come in slightly higher than expected, partially driven by segments that are less important for the Fed’s favoured core PCE measure, while forward-looking indicators suggest they will ease over the coming months.

CIBC's Jaffery aggress: "It’s also important to remember that the Fed’s preferred gauge is PCE and not CPI and the difference of shelter weights will likely mean a somewhat more tame core PCE number."

Regardless, these data will underpin the Dollar's top-performer status and further advances are likely.

That said, the Pound remains 2024's second-best performer and has actually expanded its advance against the Euro in the wake of the U.S. data.

This suggests Pound-Dollar downside will be limited as both Sterling and the Dollar appear to be favoured in the current setup in which investors look to interest rates remaining higher for longer.