Inflation updates are always a big driver of currencies. Inflation has a direct impact on the prospects of monetary policies and subsequently the purchasing power of the currency. The world is in a disinflationary spiral which in some cases, such as the Eurozone, has led to a descent into deflation and downward pressure on the currency. Last week’s news that average hourly earnings fell unexpectedly was a sign that the US is not immune, however today it was the UK’s turn to disappoint the markets.
UK CPI halved in December, falling from 1.0% to just 0.5%. This figure was well below the consensus forecast of 0.7%. It justified the weak outlook that has manifested itself in a precipitous decline for sterling against the dollar (i.e. Cable) in recent weeks. The news has created a significant amount of volatility in Cable today. An initial 40 pip sell-off was been entirely retraced, but surprisingly 3 hours after the data release Cable is actually trading 40 points higher.
The chat analysis suggests that the technical rally (which had previously seen sterling bounce by 160 pips over a two day period) has lost its way, despite the rebound. I do not see the retracement pulling too much further as I feel that the ceiling of $1.5200 is significant. Having already breached $1.5100 I expect the rally to peter out and expect Cable to retest the $1.5032 low in due course.
However, volatility can be expected to continue this week. the UK is not the only inflation data to be released this week. With the US factory gate inflation to be announced on Thursday and then on Friday there will be the CPI reading for the US too. Inflation dominates the US announcements this week and this could mean that volatility will remain high for US major pairs.
After the UK data, analysts must now be wondering whether they will need to revise down their expectations for US CPI. The oil price will be blamed (see the decline in the cost of Transport) but a look across the components of the UK inflation breakdown (below) suggests a broad based decline in prices. If this plays out in the US too, then volatility for Cable will be sure to continue. It is likely that this UK inflation data is just the start of a rocky period of trading for Sterling/Dollar this week.
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