The pound eased away from multi-month highs after inflation unexpectedly fell in June. CPI inflation retreated to 2.6% last month from 2.9% in May, which should stop the Bank of England from turning any more hawkish and delay a rate hike for a while yet.
Core inflation, which strips out volatile food and energy prices, fell back to 2.4% from 2.6% in May. The unexpectedly soft data will halt the pound’s recent rally but continued dollar weakness will offer support for cable at least. GBPUSD, having traded as high as $1.3125, its best since September 16th last year, sank by a cent to hold just above the $1.30 handle. EURGBP advanced beyond 0.885 as it retraces last week’s retreat from above 0.89.
Having slid to around $1.26 after the general election, cable has been jacked up in the last month on bets that runaway inflation would force the Bank of England to raise rates sooner than previously thought and despite the risks to the overall economy from premature tightening. A 5-3 split at the last MPC meeting and some fairly hawkish comments from some policymakers suggested the Bank was leaning closer to hiking this year, in part to correct what many felt was a premature cut to rates last year in the wake of Brexit.
But today’s slowdown in price growth should squash any speculation of a rate hike for the time being. An August rate hike now looks highly unlikely, but we should remember that the Bank has only limited tolerance for continued above-target inflation and may yet seek to push rates back up to 0.5% this year, if conditions in the wider economy improve whilst inflation remains above 2%. With pressures on consumers, slacker inflation is a good sign for aggregate demand so this may yet support conditions for a rate hike.
It does look like that the worst of the decline in sterling on import prices has passed through the year-on-year calculations, justifying the MPC’s willingness to look through the data.
Elsewhere in FX markets there are some further twists and momentum against the dollar again after the failure of Trump’s healthcare reforms sparked renewed greenback weakness.
The dollar index slid to 10-month lows as it appeared failure to get the health bill through the door has left any of the hoped for tax reforms also dead. Doubts about the pace of tightening in the US – stemming most recently from weak inflation and retail sales data, combined with a pretty sanguine outlook from Janet Yellen in her Congressional testimony, continue to weigh.
Meanwhile markets continue to bet on the ECB slowly tightening. The euro edged past $1.15 as investors dumped dollars in favour of the single currency.
Yesterday’s eurozone inflation was softer in June but core inflation managed to pick up ahead of the European Central Bank policy meeting later this week. Inflation dropped to 1.3% from 1.4% the preceding month, in line with estimates, while core inflation advanced to 1.1% from 0.9%.
The euro was trading fairly flat on the data as it’s unlikely to do anything to alter perceptions about inflation and monetary policy. EURUSD remains well supported above $1.14 and should hold above this level with ease unless Draghi imparts a decidedly dovish tone.
After the Bank of Canada’s well-choreographed hike last week, the focus is now on whether the ECB will continue with hawkish rhetoric or retreat to safer territory.
It looks more likely to hold fire. Comments from Mario Draghi last month that were taken as hawkish drove the euro to its strongest against the dollar in over a year. This looked a bit overdone and the ECB will not want to alarm markets further by stoking a ‘taper tantrum’. It also does want to add fuel to the euro fire as this will further dampen inflation expectations.
And the ECB cannot justify going significantly more hawkish now with inflation proving lacklustre. It could drop its reference to expanding quantitative easing if required. Last month it made two small changes to the monetary policy announcement – saying that risks are no longer ‘tilted to the downside’ and that policymakers don’t think rates will be cut further.
Removing this easing bias could be yet another important baby step on the road to normalisation and would likely be taken by the market as ‘euro-positive’. The ECB has tightened too quickly twice before and is loath to repeat the mistake. Any word on tapering is likely to be held back until September and the ECB might drop a hint this week that this is what it plans.
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