Dollar Surges as Hot Inflation Data Extends Rate Hike Bets

The US dollar soared to a one-week high against the Japanese yen on Wednesday, fueled by stronger-than-expected inflation data for January, as reported by Reuters. This unexpected jump in consumer prices is prompting markets to recalibrate their expectations for Federal Reserve interest rate cuts, potentially delaying the anticipated easing of monetary policy.

US consumer prices increased by 0.5% in January, exceeding economists' forecasts for a 0.3% rise. Core inflation, which excludes volatile food and energy prices, also saw a surprising increase of 0.4%, surpassing expectations of 0.3%. These figures translate to annual inflation rates of 3.0% and 3.3%, respectively, both exceeding forecasts and reinforcing the Fed's current stance on inflation.

"The takeaway is no matter what the reason was for the upside surprise, the Fed has been very clear that it won't cut rates until inflation is close to 2%," said Adam Button, chief currency analyst at ForexLive, in remarks reported by Reuters.

Interest rate futures, initially pricing in significant rate cuts by the end of the year, have now revised their expectations, implying a greater likelihood of only one 25-basis-point cut for the entire year.

The dollar's surge against the yen, a currency highly sensitive to US-Japan interest rate differentials, reflects this shift in sentiment. The dollar index, meanwhile, also saw gains, although some profit-taking and uncertainty about the longevity of the inflationary trend partially tempered the rally.

"January is a tricky month because a lot of annual price increases are announced for all sorts of things, and sometimes they are chunky," said Thomas Simons, chief US economist at Jefferies, in a note. "We are not inclined to expect a repeat next month."

Despite the unexpected inflation data, Fed Chair Jerome Powell reiterated the central bank's commitment to a gradual approach to interest rate cuts, stating that significant progress has been made on inflation. This sentiment was echoed by Bundesbank President Joachim Nagel, whose comments boosted the euro as he advocated for a gradualist approach by the European Central Bank.

While traders digest the implications of the hotter-than-expected inflation data, potential tariffs imposed by the Trump administration are adding to the uncertainty surrounding inflation.

"Potential tariffs add upside risk to inflation in coming quarters," said James Knightley, chief international economist at ING, in a note.