Consumer Price Index (CPI) data released on Tuesday the 12th of April will put pressure on the Bank of England to take a more aggressive stance on their policy of maintaining record-low interest rates.
Analysts were forecasting an inflation reading of 0.4% in March to be released by the Office for National Statistics, a shave higher than the 0.2% registered in the preceding month.
The actual figure came in at 0.5%.
Sterling has pushed higher by half a percent against the US dollar in the wake of the numbers, reflecting the market's view that the beat on expectations is a positive for the pound.
GBP/USD is quoted at 1.4286 at the time of writing while the GBP/EUR is at 1.2480.
The moves come at a time of sustained weakness in the British pound and we have only recently reported warnings that the decline could take the pound to euro exchange rate to 1.10 by mid-year; levels last seen in 2011.
We believe the British pound is oversold on a technical basis at current levels and would look for the current pullback to balance the markets.
A trigger for such a move has indeed proven to be stronger-than-forecast inflation numbers.
Why Inflation Matters
The Bank of England’s mandate is to deliver “price stability” which is translated into keeping inflation at 2%; a level that reflects healthy economic expansion while not being a threat to our pockets.
The achievement of this inflation level can be achieved through the manipulation of interest rates; lowering interest rates tends to stimulate the economy and thus ensure inflation stays buoyant.
Raising interest rates can achieve the opposite effect if the economy is deemed to be at risk of over-heating.
The by-product of all this are moves in pound sterling; the GBP tends to rise alongside interest rates as demand is stimulated amongst international investors seeking higher returns on their capital.
Why UK Inflation is Higher, Will it Impact on Bank of England Decision Making?
The Consumer Prices Index (CPI) rose by 0.5% in the year to March 2016, compared with a 0.3% rise in the year to February.
The rate has increased gradually since October 2015 although is still relatively low in the historical context.
Rises in air fares and clothing prices were the main contributors to the increase in the rate between February and March 2016.
These upward pressures were partially offset by a fall in food prices and a smaller rise in petrol prices than a year ago.
“The Easter travel rush in March will have stung many through costly air fares and higher prices at the pumps, but the fact that inflation is still stubbornly weak will give Osborne and Co. food for thought. Those observers hoping for an interest rate rise soon may be kept waiting a bit longer," says Dennis de Jong at UFX.com.
We are however a bit more bullish on sterling's prospects in the wake of the data as it confirms the fall in prices following the decline in crude oil prices may now have been fully incorporated by UK prices.
With oil prices forecast to rise into 2017 the Bank of England may start to feel a little uneasy. Like a speeding train, the brakes must be applied well before the destination is reached.