06:52 AM EST, 01/13/2025 (MT Newswires) -- Sterling has continued to underperform at the start of the week with EUR/GBP rising back above 0.8400 and GBP/USD falling closer to 1.2100, said Mitsubishi UFG.

The continued move higher in global bond yields will keep downward pressure on sterling in the near term and was one of the main reasons why the bank recommended a new short cable trade idea in its latest "FX Weekly" report. At the same time, the rebound in the price of oil is a negative development for European economies including the United Kingdom although the scale of the move isn't yet likely to have a significant negative impact, stated MUFG. At the margin, it will add to the Bank of England's ongoing caution over cutting rates further alongside the recent weakening of sterling.

The release of the latest United Kingdom consumer price index report for December will be watched closely in the week ahead to assess if inflation in the U.K. continues to prove sticky, especially in the services sector, pointed out the bank. Another sticky inflation report would normally encourage a stronger sterling by pushing back BoE rate cut expectations.

However, in the current market environment where the ongoing sell-off in Gilts is creating more concern amongst market participation over the government fiscal positions, even a stronger U.K. inflation report could be viewed more negatively for sterling.

Higher U.K. yields if they persist will increase pressure on the government to adjust fiscal policy plans, added MUFG. It has already been estimated that the increased cost of government funding is likely to use up all of the government's fiscal headroom estimated at 9.9 billion pounds in the Fall Budget.

Treasury officials have already tried to provide reassurance to market participants that the government will respect its self-imposed fiscal rules and tighten fiscal policy if judged as necessary by the independent Office for Budget Responsibility (OBR). The Spring Forecast takes place on March 26 and the Spending Review in late Spring.

The British press has already reported that the government is considering emergency tax hikes or spending cuts if required, and attempting to boost investor confidence in its growth strategy. The Fall Budget continues to draw criticism for outlining front-loaded fiscal stimulus which contributed to the BoE's caution over cutting rates further, according to the bank.