UK CPI data shocked to the downside today dipping below the 2% BoE target rate for the first time since March of 2006. CPI printed at 1.9% year over year rate versus projections of 2.3% increase. The news shaved 80 points off the value of GBP/USD in a matter of minutes as traders completely reassessed the possibility of any additional interest rate hikes from the BoE in the next few months.

As inflationary pressures recede into the background, the UK Central bank now has far less reason to maintain its ultra-hawkish posture, especially after last week’s turmoil in global capital markets that created a massive liquidity crunch. Only a surprisingly high reading in monthly wage data or a strong result in UK retail sales, both of which report later this week, could reignite speculation of additional tightening. For now, however, the idea of 6% money by the BoE in September appears to be off the table.

The news was not much better for euro bulls, as German and French GDP data printed significantly softer than forecast. German GDP for Q2 registered growth of 2.5% vs. 2.8% expected, and French GDP only managed to expand at 1.3% rate versus consensus calls of a 1.5% gain. Overall EZ GDP in Q2 of 2007 recorded growth of 2.5% vs. 2.8% expected. Weaker investment and softer export demand hampered performance, suggesting that the higher euro has had a dampening effect on growth. As we noted in our weekly, this is the first time since Q1 of 2006 that EZ GDP has been weaker than US GDP. While one quarter does not make a trend, this dynamic bears careful watching. The rally in the EUR/USD over the past year has coincided with the outperfomance of the region’s GDP versus that of the US. If that dynamic has now changed and EZ GDP will begin to lag US GDP growth, the euro could weaken further as the second half of the year progresses.

On the US calendar today, the market will get a look at US PPI figures which are expected to remain elevated at 3.3% annual rate. If the number meets or beats projections, any talk of a possible Fed rate cut is likely to disappear as US inflationary pressures will prevent the FOMC from loosening monetary policy. Unless equity markets once again go into a freefall, the consensus view in the currency market will expect the Fed to hold steady, while at the same time expressing doubt about the upcoming ECB rate hike in September, given the lackluster GDP data and the tepid inflation readings in the 13 member region. In short, dollar bullish momentum may continue if US inflation data remains hot. What a difference a few weeks make. Last month most market players shared a diametrically opposite point of view.

Boris Schlossberg is a Senior Currency Strategist at FXCM.