Image © Adobe Images
Pound sterling will likely drift lower in the coming days following an on-target inflation release, but remain constructive in the medium term.
The GBP/EUR tide: just like a wave that breaks on a beach and then retreats back into the ocean, the immediate-term pullback in sterling can extend, but medium-term the tide is still coming in and further gains are therefore possible.
That's the context in which the midweek inflation release arrives: it doesn't do enough to arrest this week's short-term slide, while at the same time it could enhance the medium-term uptrend.
Short-term: there are no scary developments in today's CPI numbers that would cause anyone at the Bank of England to sit up and take notice and consider a strategy rethink. That means there was no trigger on the day to shift GBP/EUR direction.
Medium-term: it's clear that inflation is stuck above the 2.0% target and will be for some time, which will support UK bond yields and offer the pound a residual carry advantage. That makes GBP/EUR a buy-on-dips candidate.
How the Inflation Numbers Landed
Headline UK CPI inflation rose to 2.9% y/y in July from 2.6%, a figure that met expectations. The monthly rate shifted from 0.1% m/m to 0.3% in July.
There was something of a 'hawkish' outturn from the core component, which rose to 0.2% m/m in July, beating estimates of 0.1%.
Nevertheless, the headline takeaway is that there's nothing alarming in the data and probably not enough to materially shift the thinking on what the Bank of England might do in the coming months.
"The headline rise reflects the increase in the Ofgem price cap introduced this month, which was partly mitigated by a further moderation in food inflation," says a reaction note from Lloyds Bank.
The FX Market Reaction
The current expectation is that two rate hikes will be delivered by early 2027 in order to deal with the seemingly persistently high inflation dynamics.
The pound-to-euro rate edges higher to 1.1689 at the time of writing, putting it more or less where it was ahead of the inflation release.
The trend this week has been a soft one for the pair, and these numbers don't discount further softness over the coming days.
"The swaps curve price-in 50bps of BOE rate hikes in the next twelve months. That’s too aggressive in our view given the UK’s negative output gap, and leaves rate-hike expectations vulnerable to a dovish repricing. For now, the UK’s favorable growth-inflation mix offers GBP good support," says Elias Haddad, Global Head of Markets Strategy at Brown Brothers Harriman.
The softer tenor to GBP price action follows Tuesday's release of labour market figures that showed there's still ample slack in the economy, meaning employment is running below potential.
Employment rose 84K on a three-month-on-three-month basis, the unemployment rate held at 4.9%, and annual wage growth ran at 4.3% including bonuses and 3.4% on the regular measure.
Yet, vacancies continued to fall, hitting 712K and the PAYE measure of employment actually fell 12,850 on the month.
According to analysts we follow, the numbers provide evidence that diminishes the odds of a rate rise at the Bank of England, and the numbers therefore provide evidence that justifies a 'bearish' stance on the pound over the coming months.
"UK single month unemployment jumped to highest since Oct 2020. While it may get revised, UER trend now turning for the worse. Following stagnant job listings & higher layoffs in high-freq data. Private pay growth sub-3% for 3M in a row says there’s no need for BoE hikes," says Viraj Patel, FX & Global Macro Strategist at Vanda Research in the wake of the data release, referencing the GBP.
Although sterling is weakening against the euro there's nothing in the domestic numbers to suggest that the medium-term trend is at risk of turning.
For now, the economy is robust enough to ensure that any weakness in the exchange rate is a counter-trend dip that will ultimately be bought into.
