(Bloomberg) -- The pound rose to the strongest in over two months against the euro after UK inflation slowed less than expected, threatening to delay interest-rate cuts from the Bank of England.

Traders pared bets on monetary easing from the BOE aggressively and now only see the first reduction coming in September, three months after the first expected cut from the European Central Bank.

Stronger-Than-Expected UK Inflation Tempers Rate Cut Bets

A June rate cut “is off the cards” said Neil Jones, a foreign-exchange salesperson to financial institutions at TJM Europe.  “Frankly, August will hang in the balance.”

As recently as Tuesday, the market was betting the BOE could start cutting interest rates next month — in lockstep with the ECB — and deliver two quarter-point reductions this year. But that narrative is crumbling, especially as the latest data shows signs of persistent domestic price pressures.

The pound gained as much as 0.4% to 0.8504 per euro, the strongest since February. Attention later turned to speculation that Rishi Sunak will call an earlier-than-expected UK election in the summer, though the market impact was muted.

For gilts, the repricing in the outlook for interest-rates was a drag, with the yield on 10-year bonds rising as much as 12 basis points to 4.25%. Two-year rates were up as much as 15 basis points to 4.46%. 

“The market is currently obsessed with the timing of the first rate cuts from the big central banks and the move lower in EUR/GBP reflects the increased likelihood that the BoE will not be accompanying the ECB with a rate cut in June,” said Jane Foley, head of FX strategy at Rabobank.

UK consumer prices grew 2.3% from a year ago in April, more than the 2.1% forecast by economists. Of particular concern for investors will be the outlook for services inflation, which remained little changed at 5.9% compared to a 5.4% forecast. 

“Service inflation remains key for the BOE as it uses it as a measure of inflation persistence,” said Kirstine Kundby-Nielsen, a strategist at Danske Bank. “We get another inflation print the day before the June BOE meeting but June meeting looking more unlikely now.”

In Europe meanwhile, growth remains weaker and core inflation is cooling. Markets have nailed on a quarter-point rate cut next month from the ECB, and see at least one more reduction before year-end.

“The fact that the ECB could be starting its easing cycle ahead of the BOE next month could further add to the downside pressure on EUR/GBP,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole.

(Updates with UK election talk in fifth paragraph.)

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