GBP/USD trades above 1.2650, upside potential seems limited due to cautious Fed

• GBP/USD holds thin gains as the US Dollar corrects downwards despite cautious Fed officials.
• The upside of the pair could be restrained due to safe-haven flows amid the escalated Russia-Ukraine war.
• A hotter UK inflation report has bolstered the BoE caution toward future interest rate reductions.

GBP/USD edges higher to near 1.2650 during the Asian trading hours on Thursday. This downside could be attributed to the softer US Dollar (USD). The US Dollar Index (DXY), which measures the value of the USD against its six major peers, holds ground near 106.50 at the time of writing.

However, the downside risk for the US Dollar may be constrained due to the cautious remarks from Federal Reserve (Fed) officials. Boston Fed President Susan Collins stated on Wednesday that while more interest rate cuts are necessary, policymakers should proceed cautiously to avoid moving too quickly or too slowly, according to Bloomberg.

Meanwhile, Fed Governor Michelle Bowman highlighted that inflation remains elevated over the past few months and stressed the need for the Fed to proceed cautiously with rate cuts.

A Reuters poll indicated that nearly 90% of economists (94 out of 106) anticipate a 25bps cut in December, lowering the fed funds rate to 4.25%-4.50%. Economists predict shallower rate cuts in 2025 due to the risk of higher inflation from President-elect Trump's policies. The fed funds rate is forecasted to be 3.50%-3.75% by the end of 2025, which is 50bps higher than last month’s projection.

The upside potential for the GBP/USD pair seems restrained due to safe-haven flows amid the escalated Russia-Ukraine conflict. On Wednesday, Ukraine launched a volley of British Storm Shadow cruise missiles into Russia, marking the latest deployment of Western weaponry against Russian targets. This follows Ukraine's use of US ATACMS missiles the previous day.

On Wednesday, a stronger-than-anticipated UK inflation report bolstered the Bank of England's (BoE) cautious approach toward future interest rate reductions. UK CPI inflation surged to 2.3% year-over-year in October, marking a six-month high, up from 1.7% in September and beating forecasts of 2.2%. Meanwhile, Core CPI, which excludes the more volatile food and energy prices, climbed to 3.3% over the same period, outpacing market predictions of 3.1%.