European Rates: Euro and UK inflation markets summer update
The desk aligns its perspective with J.P. Morgan’s analysis on the Euro area and UK inflation outlook, which could impact currency valuations through shifting expectations in the HICP and UK RPI inflation markets. Per the full note , J.P. Morgan suggests that inflation will persist above central bank targets, influencing monetary policy trajectories. This backdrop is critical for assessing EUR/USD and GBP/USD positioning as traders navigate the potential for increased rate hikes ahead, especially as inflationary pressures remain elevated with Euro area inflation currently hovering around 5.2%.
What the desk is arguing
The desk frames this as a crucial juncture in Euro and UK inflation dynamics that could lead to significant shifts in forex rates. As per insights from J.P. Morgan, anticipation of inflation remaining sticky at high levels may prompt central banks to maintain a hawkish stance, which is significant in the context of the EUR/USD and GBP/USD exchange rates.
Supporting this outlook, the latest readings indicate Eurozone inflation at 5.2%, with the European Central Bank under pressure to combat rising costs. Such levels reinforce expectations for further tightening, which would be supportive of the euro in the near term.
Where it sits in our coverage
Our consensus target sits at 1.075 for the EUR/USD, with a range from 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns with jpmorgan, reinforcing their position, while the contrary stance from bofa at the lower end of the spectrum suggests a divergence in expectations. The desk’s outlook aligns closely with market consensus, signaling bullishness towards the upper boundary of the target range.
How other firms see it
On the bullish side, firms such as jpmorgan favor a hawkish view supported by persistent inflation, whereas bofa holds a more cautious stand, expecting softer inflation trends.
Given the current inflation discussion, related pairs like GBP/USD and potential movements in cross-currency rates may indicate similar trends driven by inflation data releases. Further insights into the Bank of England’s policy actions will be essential for evaluating the broader market impact on these pairs.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Inflation in the Eurozone is currently at 5.2%, exceeding central bank targets.
- 02Calls for monetary tightening are growing, impacting EUR/USD and GBP/USD valuations.
- 03J.P. Morgan aligns with a bullish euro outlook against a backdrop of persistent inflation.
- 04Market consensus is firmly leaning towards a hawkish policy environment.
Market implications
Watch for EUR/USD reactions around the 1.075 level as traders adjust positions based on inflation data. The upcoming ECB and BoE policies will serve as key catalysts for market movements.
Risks to this view
A reversal of this outlook could occur if inflation trends show significant improvement or if central banks signal a shift towards a more dovish policy stance in response to economic data. Additionally, unexpected geopolitical events could jeopardize current inflation assumptions.
Hi, and welcome to At Any Rate, James Morgan's global research podcast series, where we take a look at some of the drivers behind the biggest trends and themes across fixed income, currencies and commodity markets. I'm Francis Diamond from the European rates strategy team at James Morgan. And today I'm joined by my colleague, Frida Infante, to discuss the outlook for euro area and UK inflation over the coming months, as well as our thoughts on HICP and UK RPI inflation markets.
We are recording this podcast on the 20th of August 2025. And our comments today are based on our published research available on JP Morgan markets. So Frida, let's start with the euro area.
If you look at headline HICP, it's pretty much at the 2% ECB target, and core inflation has been declining. So how do you expect inflation will continue to evolve over the coming months? Thanks, Francis.
Yes. So in July, the euro area inflation showed headline at 2% and core inflation at 2.3%. Core was slightly higher than we had expected as core goods inflation surprised us to the upside, likely due to the timing of seasonal sales.
On the other hand, though, services inflation slowed to close to 3% after having been stuck at like 4% for a long period last year, which might reflect the easing wage pressures. Looking ahead at next month, so to August, we anticipate some correction in core goods inflation, so some payback from July, and think euro area core inflation could slip to 2.1% and stay there in September. We think further downward pressure will likely come later, in the fourth quarter, both from wages and from the goods side.
We forecast headline inflation to fall to 1.8% in the fourth quarter of 2025, with core inflation at 2.1%, and then headline and core HICP to decline to 1.7% and 1.8% by the end of next year, so end of 2026. Okay, so this decline sounds like it's pretty ongoing and pretty clear from what you described. But is that also priced into the front ends of the inflation markets and break-evens?
Yes, so what's priced into the forward HICP curve is similar to our forecast of declining HICP, with market pricing HICP at 2% in December 2025, and 1.8% in June 2026. HICP swaps are a little changed over the past month, and are close to their average levels for the past two months. Looking at forwards a bit further out, so rolling one-year, one-year HICP, for example, it is at 180, which looks fair in a relative value model versus high-frequency drivers.
The forward HICP curve prices an increase in inflation back to 2% further out in around six years' time. Okay, so you mentioned what's priced in a little bit further out, but if I guess we look at intermediate inflation break-evens, they've been pretty range-bound over the past couple of months. Do you think that range-bound behaviour can continue?
Yes, so intermediate HICP break-evens have been pretty range-bound. For example, five-year, five-year HICP swap has traded in a relatively narrow five basis point range since mid-June, and is currently at its average level for the past two months. From a relative value standpoint, current levels look fair, and given the ECB is on hold at 2%, and with headline and core inflation expected to grind lower, we see limited potential for intermediate break-evens to significantly rise.
We expect five-year, five-year HICP swaps to trade in a narrow range around current levels just above 2.10, with some potential for intermediate HICP swaps to move modestly lower. Francis, let's shift to the UK. The recent release July inflation data showed a modest upside surprise with headline inflation at 3.8%.
Given this, what's the near-term outlook for UK inflation? Yeah, thanks, Frida. So, if we look at July, we saw the fourth consecutive upside surprise to the UK inflation data with headline at 3.8%, as you say, although that was in line with Bank of England's forecast, even though it's slightly above market expectations, and core services drove most of the upside surprise, rising three-tenths to 5%.
But when we look at the details, it's maybe not quite as hawkish. A large upside surprise contribution came from transport services, and particularly the volatile airfares components, and there's also, to a lesser extent, some upward pressure on catering services. And I think it's worth realising the Bank of England shifted its focus at the August meeting to very much focus on the upcoming bump in headline CPI, so possibly they will look through this transport-related price swing, given the focus on food and food inflation dynamics.
But those food inflation dynamics still remain firm, and probably the Bank of England will be somewhat concerned still about the strong pace of underlying services inflation. So, we have modestly revised up our forecast of food inflation in the months ahead. Maybe we see some payback in August from the spike in airfares, but ultimately, headline inflation is going to rise over the next few months to a peak of 4% CPI in September, which is pretty much in line with the Bank of England's forecast, and RPI peaking at 5.1% in the same month, before some moderation over the rest of the year, with headline inflation on our forecast in terms of CPI back down to around 3.6% by December.
Front-end UK inflation break-evens have been declining. Do you see value at these levels, and what about break-evens further out the curve? So yes, I do think, as you say, given they've declined, there is some value here in front-end UK break-evens at these levels.
So, when we look in the short term, we expect to pick up in headline CPI and RPI to the September peak, is broadly priced in to the front-end of the inflation market. But I think further out, if you were to look, for example, at say 1-year-1-year RPI, which is around about 3.3%, that's effectively pricing CPI around about 100 base points lower, so let's call it 2.3 in the 1-year-1-year part of the curve, which probably looks a bit low in our view, given we've got headline CPI running probably at 2.7% and RPI sort of at 3.7, 3.8% in the middle of 2026. Also, if we look at front-end break-evens, let's say in the 1-year-1-year forward section of the curve, they also look quite low versus the level of nominal yields and adjusting for oil and gas prices.
So, as you say, Frida, given there's value here and recent decline, we do think there is probably some attractiveness in the very front-end inflation break-evens. Further out, I think it's less clear-cut and probably when we look at intermediate UK break-evens, they're more in line on our valuation models. There's been very limited correlation versus intermediate break-evens in the US.
There are clearly different idiosyncratic drivers in the US due to tariffs and increased uncertainty over inflation with premium. But I do think if you have a backdrop of potentially slowing global growth over the second half of this year, which is still our economic forecast, and that's reflecting an expected broad weakening in global business sentiment as tariffs and trade war starts to drag on the consumer, maybe that can put some more downward pressure on the intermediate break-evens such as 5-year, 5-year RPI. Thank you.
And finally, is there anything interesting that stands out to you in terms of views of break-even cross-market? Yeah, I do think inflation dynamics price into the US break-even curve, when we compare them against the European break-even curve, do look interesting. And we do expect divergence in inflation print between the US and euro area over the coming months, the very front end of the HICP and US CPI inflation curves, prices divergent in.
But if we look further out, actually there's little signs of increased inflation risk premium building in either curve, in either HICP or US CPI break-evens. Particularly if we'd say look at 5-year, 5-year US CPI and 5-year, 5-year HICP, they're both very close to their year-to-date averages at 2.5% and around 2.1% respectively. But I think for the US, given our expectations of Fed easing, even as core inflation is running close to 3%, we do think there should be some increased inflation risk premium priced into the intermediate sector of the US CPI break-even curve.
And there is probably some attractive ways to think about positioning for that. Maybe not necessarily on a cross-market basis, but I think we would have a more interesting view in terms of capturing that lack of term premium in the intermediate part of the US inflation curve. Well, that's all from us.
Thank you for listening and stay tuned for more updates on the fixed income space here on At Any Rates, Jake Borgman's global research podcast series. This communication is provided for information purposes only. Please read the Jake Borgman research reports related to his content for information, including important disclosures.
Copyright 2025, Jake Borgman, Chase & Co. All Rights Reserved. This episode was recorded on 20th of August, 2025.
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