Pound Put on "Negative Watch" Following Negative Reaction to Hot CPI Inflation Data Release

  • GBP falls against EUR and USD despite strong inflation read
  • Leads some to warn GBP is returning to 'crisis' mode
  • But UK inflation to fall sharply say economists
  • And GBP outperformance against other currencies continues

Image © Adobe Images


The British Pound is back on "negative watch" with some foreign exchange analysts who have grown concerned by the currency's inability to hold a rally following the release of stronger-than-expected UK inflation midweek.

The UK currency rose against all its major peers after CPI for April beat expectations but turned and fell against the Euro, Dollar and a handful of other names.

This in itself is not unusual; instead, the story some analysts are picking up on is that the Pound and UK bond yields diverged.

Investors saw the inflation numbers and raised expectations for more Bank of England interest rate hikes over the coming months, with a further three 25 basis point hikes now expected. This prompted a selloff in domestic bonds and a surge in the yields paid on those bonds.

Jordan Rochester, FX strategist at Nomura, says under a typical scenario, higher yields attract sufficient foreign capital to offset domestic bond selloffs and would therefore be considered supportive of the Pound.

"Why is GBP not following its rates/data surprise with CPI inflation?" queries Rochester. "In the context of today’s large rates move... it's odd not to see GBP moving much more."


Above: GBP/EUR (top) and UK 2-year bond yields.


The Pound to Euro exchange rate (GBPEUR) rose to 1.1563 in the wake of the data - its highest level since December - but it soon retreated to sub-1.15 as markets queried whether strong inflation is really a good thing for the UK economic outlook.

Indeed, the above chart would suggest GBPEUR would be at around 1.1560 at the time the snapshot was taken if the positive correlation between the currency and UK two-year yields had held.

The Pound to Dollar exchange rate (GBPUSD) meanwhile rose to 1.2469 before retreating back to where we find it at the time of writing at 1.2388.

"Safe to say that sterling is back on negative watch," says Saxo's Hardy.


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For Rochester, the Pound's reaction "is not that surprising".

"GBP has ignored rates spreads several times before in periods of crisis since 2016's EU referendum and rightfully so," he says, adding that the Pound's selloff is a potential consequence of investors raising concerns of the prospect the UK will suffer stagflationary conditions.

Stagflation is where an economy is mired by high inflation and low growth.

"A stagflationary economy leaves both fiscal and monetary authorities in a bind with no room for manoeuvring," says Saxo's Hardy.

Hardy says Pound-Dollar looks set to break down further and eyes local support in the 1.2350 area, initially.


Live GBP/EUR Money Transfer Exchange Rate Checker
Live Market Rate:
get quick quote
Corpay:
Banks:
Median Low
Banks:
Median High
These data are based on the spread surveyed in a recent survey conducted for Pound Sterling Live by The Money Cloud.

He expects Pound-Euro to also come under pressure as it rejected a new multi-month high earlier today.

Nomura has been a seller of Pound Sterling into today's inflation release, with economists at the investment bank betting inflation would undershoot expectations.

Predictions for an undershoot proved off-target but the currency market has nevertheless obliged.

"Sticky inflation in the UK will prolong the length of the BoE rate hike cycle = lower growth, less UK inflows," says Rochester.


Above: "If yields were in charge, GBP would be much stronger. But correlation breakdown and buying GBP with stagflation concerns is a problem" - Nomura.


But could stagflation fears prove overblown?

"Even though consumer price inflation has not yet started to fade quite as quickly as expected, it still remains a question of when rather than if inflation moderates," says Kallum Pickering, an economist at Berenberg Bank.

There are signs of sharper falls ahead as producer price (PPI) pressures eased by more than expected in April. The below chart shows headline inflation tends to lag PPI:


Image courtesy of Berenberg.


PPI Output prices slowed to 5.4% year-on-year in April from 8.5% in March, while input prices eased to 3.9% from 7.3% over the same period.

"If history is any guide, the big drop in producer price pressures should lead consumer prices for goods lower within three to six months," says Pickering.

Furthermore, falls in headline inflation in coming months are guaranteed as energy price base effects fall away and food prices moderate.

"Headline CPI will continue to fall sharply over the coming months as base effects weigh. Tomorrow, Ofgem will announce the price cap for household energy prices, which we expect to fall to around £2,000 from July, which will ensure that energy's contribution continues to decline further over the coming months," says Modupe Adegbembo, G7 Economist at AXA Investment Managers.

The notion Pound Sterling is headed back into crisis territory will also be questioned by the Pound's ability to hold significant gains against the New Zealand and Australian Dollars.

The Pound-New Zealand Dollar surged higher on the day as markets sold the Kiwi in reaction to the Reserve Bank of New Zealand's communication that it had ended its interest rate hiking cycle, a development that surprised analysts.

To summarise: the Pound was sold against the Euro and Dollar because markets raised BoE raised rate hike expectations and the NZ Dollar was sold because markets lowered RBNZ hike expectations. This hints at some contradictions.

The Australian Dollar appears to have been sold off given similar expectations at the Reserve Bank of Australia.

The currency market is therefore full of contradictions, as is often the case, and while GBP outperformance has come to an end it could yet prove premature to punish it over expectations a crisis is brewing in the UK once more.

Live GBP/EUR Money Transfer Exchange Rate Checker
Live Market Rate:
get quick quote
Corpay:
Banks:
Median Low
Banks:
Median High
These data are based on the spread surveyed in a recent survey conducted for Pound Sterling Live by The Money Cloud.