The pound sterling is rallying again buy a soft set of inflation data appears to have dented the positive sentiment GBP currently commands.
- UK inflation comes in below analyst expectations, GBP gains are capped
- Unemployment forecast to have risen, further placing pressure on the Bank of England to keep raise unchanged for months to come
The British pound got off to a flying start on Tuesday the 17th of May as an oil-lead stock market rally carried along those currencies which have a strong correlation to risk.
We have noted that GBP is one such currency.
But, the pound has certainly come off the boil in the wake of the data release: The GBP to EUR exchange rate has fallen from highs at 1.2819 and is at 1.2783 while the GBP to USD exchange rate has fallen from highs at 1.4524 to 1.4470.
Sterling had been tracking the German DAX higher ahead of the data - the DAX is 0.9% higher on the day and pressing new highs while sterling is going in the opposite direction confirming the inflation data to be responsible.
From late 2015, the rate began to increase gradually from close to zero. The drop in April 2016 is the first fall since September 2015.
Falls in air fares and prices for clothing, vehicles and social housing rent were the main contributors to the decrease in the rate.
UK inflation has been falling since September 2011 when it peaked at 5.2%. The global oil price slump is one reason why prices actually fell into deflation in 2015.
“Governor Mark Carney is expected to write an open letter to Chancellor George Osborne whenever CPI inflation misses its target by more than one percentage point, and he will need to get his pen and paper out once again after today’s data," says Dennis de Jong, Managing Director at UFX.com.
de Jong says there are however signs inflation could finally tick upwards in the second half of the year as oil prices strengthen and earnings pick up off the back of the new National Living Wage.
"Some observers suggest that the two percent target could be attainable by late 2017, although forecasting too far into the future isn’t recommended until the outcome of the UK’s vote on EU membership is known," says de Jong.
UK economic data released over the past two months has confirmed the UK economy is slowing; and this has presented a drag to the currency which has come under pressure over the course of May.
Economic data influences the British pound via the Bank of England who is tasked with setting the appropriate interest rate levels that reflect underlying economic activity.
In turn, interest rate levels determine how much demand there is for the local currency amongst global investors.
The Bank of England has continued pushing back their guidance on when to expect the first interest rate rise in years based largely on the performance of inflation.
The Bank simply had to delay interest rates when faced with soft inflation - low inflation is bad news for the economy as it pressures profit margins at UK businesses who are unable to raise prices, they in turn see little justification in raising pay for a workforce whose productivity subsequently suffers a decline.
The government also relies on inflation to whittle away at their debt pile and thus aids as a benign deficit reduction tool.
This is why the Bank of England targets inflation at 2% over the long-term - it is widely held to be the level at which inflation is considered ‘healthy’.
Employment Data Could be Key
Also on the data docket this week is employment and wage data and some analysts argue this is the one to watch out for.
High employment and rising wages also puts pressure on prices, and if the data here beats forecasts we would therefore expect the Bank to eye an interest rate rise.
UK employment is also expected to have softened. Although vacancies remain high, near-term economic uncertainty is expected to have led to a drop in employment in the latest three months. Markets are forecasting the claimant count to have risen by 4K people.
The unemployment rate, however, is predicted to be unchanged at 5.1%.
Markets are likely to focus on the employment drop and a decline in wage growth from 1.8% to 1.7%).
“Both are these are likely to cement expectations that UK interest rates are going nowhere and could weigh on the pound,” says Chester.
April retail sales will round off this week’s domestic data set.
Surveys of retail strength over the past month have been mixed, with the CBI and John Lewis reporting firmer sales, but the BRC suggesting little change after a 1.3% drop in March.
“We suspect the March outturn may have been impacted by the Easter storms and look for a 0.8%m/m rebound, leaving annual growth at 2.7%” says Chester.
EU, US Inflation Also on the Docket
April inflation data will also be released in the US and euro area.
The rise in oil prices is expected to have pushed US consumer price inflation back above 1.0% for only the third time since late 2014.
By contrast, given the downward revision to Italian inflation in April, the euro area reading is likely to be lowered, from -0.2% to -0.3%.
The US April industrial production report is also due, as well as the minutes of the last Federal Reserve policy meeting held in late April.
The minutes will be scrutinised for the Federal Reserve’s thoughts on policy.
“Although we no longer expect the US interest rates to rise next month, the bounce in retail sales in April, and the recent rise in inflation and wage growth suggest the 4% probability attached by the market to a rise next month is too low,” says Lloyds’ Chester.