Pound Sterling Rises Against Euro on Inflation Spike

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The British pound advanced against the euro after it was reported UK services inflation beat expectations in March, according to new figures released by the ONS.

Services CPI rose 4.5% versus 4.3% expected in March, up from 4.3% in February. This was a headline CPI inflation jump to 3.3 in March from 3.0% owing to a surge in oil prices.

"The main point of concern will be that services inflation, which is stickier by nature and thus more of a headache for policymakers, rose 0.2ppts to 4.5% y/y," says Sam Hill, Head of Market Insights at LLoyds Bank.

The data will therefore make for uncomfortable reading at the Bank of England and raises the prospect of an interest rate rise later in the year, even if next week's decision is to hold. This would be, on balance, supportive of pound sterling.

The pound-euro exchange rate rose to 1.1509 following the midweek data release, taking it to April's high water line, and we will be watching to see whether the shift in rate expectations is enough to trigger further gains. (By the way, our Q2 GBP/EUR consensus forecasts, derived from tier-1 investment banks, are now out).

"The Bank of England will stay put when it meets next week. Markets are interested in reaction functions from the ECB and the BoE to help decide on the faith of EUR/GBP," says a note from KBC Bank in Brussels.

The pound-dollar meanwhile records a small daily gain to 1.3522, underpinning recent support above 1.3480, although for this pair it will be the global picture that matters more.

Services PMI is arguably the most important figure in today's data batch because it is of particular relevance to the Bank of England.

The Bank knows an inflationary spike will follow the Iran War, which has sent oil and gas prices soaring. But there's little it can do about that.

Instead, it's services and core inflation that will matter for the Bank of England; these are the elements of inflation that are determined by the domestic economy, and changing interest rates can have an impact.

Above: Stubborn services CPI limits headline CPI's ability to fall to the 2.0% target.

That services inflation was hotter than expected will be of concern and will warn the Bank that domestic prices could follow energy prices higher in the coming months. That raises the risks of another embedded inflationary surge.

To be sure, core CPI edged lower to 3.1% from 3.2%, which was softer than consensus estimates for 3.2%.

Bottom line, though, is that these figures are all far too high for the Bank to consider cutting interest rates, particularly given the recent above-consensus GDP and labour market prints.

For the pound, today's numbers are ultimately supportive inasmuch as they suggest UK rates will remain higher for longer.

Above: The UK has elevated inflation relative to comparable economies. This implies the Bank of England can't cut faster than peers, and that should ultimately prove supportive for GBP.