The April CPI data was stronger than expected, which helped GBP/USD to extend its recent recovery. The headline CPI rate rose to 1.8%, from 1.6% in March, which was the strongest level since January. Core CPI was stronger at 2%, the highest level since September last year.
An increase in transport costs, according to the Office for National Statistics, was the chief driver of stronger CPI, notably air fares, sea fares and motor fuels. On the downside, there was a decline in the price of food last month.
In its report, the ONS added that the timing of Easter “is likely to have had an impact on the index”, thus, this increase in prices could prove to be temporary. This is supported by the decline in producer prices, input costs fell 1.1% last month, while output prices were flat. Producer prices are further up the UK’s inflation pipeline than CPI, so when they are weak it can lead to reduced price pressures down the pipeline.
We believe this last month’s increase in prices was temporary, and we could see a further moderation in the coming months. This supports the sentiment from last week’s Bank of England Inflation Report that price pressures may remain subdued for some time to come and rate rises are still some way off.
The market impact:
The pound jumped to its highest level in 5 sessions on the back of the inflation data. After correcting over for most of this month, the downside stalled last week just above critical support at 1.6728 – the 50% retracement of the March – May advance. Momentum has crossed higher on the short term charts, which suggests that there could be further upside to come.
However, if the broader inflation trend remains weak and the BOE is likely to keep rates on hold for some time then upside could be limited in the medium-term. The bond market supports this view, as yields have been fairly subdued on the back of the inflation data, and they remain some way off the 13th May highs at 2.74%.
In the short-term, any further upside could be dependent on momentum. If we can’t get above 1.6864 – the midpoint of the latest sell off – in the near term, then the prospect of getting above 1.70 seems unlikely. However, if we can clear this level then 1.7043 – the August 209 high – comes into view.
As we mention above, 1.6728 – a key Fib and trend line support level (see chart below) – may cushion the downside in the medium-term.
Takeaway:
Overall, although we believe that the trend in inflation remains weak, GBP/USD hasn’t suffered since inflation started to moderate in the middle of 2013. GBP/USD is worth watching in the next day or so to see if we can get above 1.6864 and make some headway towards 1.70.
Although we believe that the trend in inflation remains weak, GBP/USD may be immune if it can clear the technical obstacles.