The pound is the strongest performer in the G10 space so far today and recently made a fresh high ahead of the UK lunchtime. The key driver of the pound was stronger than expected inflation data, with headline CPI rising to its highest level since January and core CPI rising to 2%, the Bank of England’s target rate.
So why did inflation jump from 1.5% to 1.9% when the market was expecting 1.6%? The Office for National Statistics (ONS) blamed clothing, food and increases in air fares as exerting the most upward pressure on prices last month.
Clothing prices normally fall between May and June as the summer sales kick in, however, this year the average price has risen. The ONS singled out women’s outerwear for particular mention “particularly items such as trousers and skirts.”
Aside from the female shopping spree between May and June, vegetable, bread and cereal prices were also singled out for contributing to the increase in CPI. Airfares tend to rise in the summer months, however, this summer the impact was greater because last summer airfares actually fell.
The ONS reminded us that housing, and bills still have the largest impact on inflation, contributing approx. a quarter of the total, however there was some good news for consumers, average petrol prices are around GBP 1.30 this June, compared with GBP 1.34 last year.
So is the rise in inflation permanent?
Some of the rise could be down to the summer weather, if one can assume that shorts are included in the women’s trouser category.
Likewise, food prices can also rise in the summer months as BBQ’s get dusted off and put to good use. Airfares also tend to fall later in the year, once demand drops, so we can’t be sure that inflation won’t moderate later this year.
Looking at today’s data release more closely, there are signs that pressure at the top of the inflation pipeline is still weak. Producer prices were weaker than expected last month, input prices fell 0.8% on the month, with the annual rate dropping to -4.4% from -3.8%.
Output prices are rising at a 0.2% rate, with the core rate holding steady at 1%. All producer prices are currently below the BOE’s target 2% rate, which suggests that once temporary factors start to fade, CPI may not be able to sustain June’s gain.
The impact on the pound:
Sterling has been remarkably resilient in the face of weakening price pressures in recent months, rallying to multi-year highs. Today’s surprise jump in CPI triggered a recovery in GBPUSD, which managed to claw back yesterday’s losses.
It is unclear why GBPUSD sold off to 1.7060 yesterday, it may have been in anticipation of weaker inflation pressure, however, it managed to close Monday’s session above 1.7067 – the mid-point of the latest advance.
This suggests that the uptrend remains in-tact, and any set-back could be limited. It appears that weakness in sterling is attracting buyers, and we continue to think that 1.7332 – the 50% retracement of the Nov 2007 – Jan 2009 decline – remains in view.
If we get stronger wage data on Wednesday then this could accelerate the next advance for GBPUSD.
Our view that there could be further upside in sterling is not dependent on prices continuing to rise, as Bank of England Governor Mark Carney said earlier on Tuesday that CPI expectations are “anchored and have improved”.
Thus, if long term, inflation expectations remain around 2%, then the BOE may still feel confident to raise rates even if prices moderate, which could keep the pound well supported.
Conclusion:
- • The jump in CPI was unexpected, but could be down to temporary effects.
- • Pressure further down the inflation pipeline remains subdued, which could cause CPI to moderate later this year.
- • The pound surged on the back of the CPI report, and is the leading performer in the G10 FX space.
- • Even if prices do moderate from here, we continue to think that we could see further gains in GBPUSD.
- • The BOE may also hike rates if CPI remains below its target 2% because Carney said that inflation expectations remain well-anchored, which also supports our GBP view.
Figure 1:
Source: FOREX.com and Bloomberg
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.
Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.