Another big week ahead for UK inflation – Sterling Update

GBP 

Amongst key UK economic releases this week, there was an unexpected increase in the latest ILO unemployment rate, which jumped from 3.8 to 3.9% during March. There were also higher claims than expected, with an increase of 46.7K against an expected decline of around 11K over the period. Much the same as in the US and Europe, the UK Labour market has remained tight for some time, so the sudden deterioration could be telling us something about the prospects for the broader economy.  

On that note, incoming UK economic data will continue to be closely scrutinized by both the BoE and markets alike, as they try to assess whether the economy is rigid enough to sustain further interest rate hikes, given ongoing double-digit UK inflation. 

That key inflation update is released on Wednesday next week, with the latest estimates predicting another month of gains, which could result in a rise on the headline from 10.1 to 10.4% during April. Bank of England governor, Andrew Bailey, highlighted earlier in the week that the UK was dealing with a wage price spiral. Speaking at the British Chambers of Commerce annual conference, Bailey implied that the UK was now going through the ‘second-round’ effects of inflation, suggesting that the sudden increase among energy and food prices has impacted wage and price setting among companies, which in turn helps to fuel further increases among inflation.  

UK inflation does seem unreasonably high given the marked slowdown in overall inflation in the developed world. As we have highlighted before, UK inflation is currently running at almost the double the level of the US. No doubt there are UK-specific factors behind the math, such as Brexit, logistics and a lack of qualified lorry drivers, given that much of the food we eat is transported this way.  It has also been noted that the large supermarkets have been slow to pass on much of the recent drop in oil prices at the forecourts. The Supermarkets matter, given that they supply around 50% of all petrol (gas) sales, and over 1/3 of total fuel sales.  

As long as inflation remains frothy, the BoE will remain in hiking mode, and to that end markets currently predict another two rate hikes from the BoE before they likely reach their terminal* rate. That should help to keep the pound fairly well supported, given that many of the major central banks have, or are planning to, move to a pause in their respective hiking cycles. However, sterling has struggled this week against a broadly stronger dollar, with GBP/USD dropping from a one-year high at over 1.2675, to under 1.2400. However, at the same time GBP/EUR moved back over 1.1500, implying a more robust pound outside of the cable mix.  

*Terminal is the end or final rate.  

EUR 

It has been a tough week for EUR/USD bulls, with the pair continuing to decline, having dropped by around 1.7% during last week. As of yesterday (Thursday), the pair slipped below 1.0760, which is a two-month low for the pair. Given that we were recently trading at a one-year top (above 1.1050), the turnaround has been quite spectacular. What has caused the move? Well, aside from the USD side of the pair (and that really matters), European data has played a part with news that regional inflation rose less than expected during April. Headline inflation increased by 0.6%, against an expected 0.7% jump. However, core inflation remains at 5.6% on an annual basis, so that should still keep the ECB in a fairly hawkish mood.  

Germany could also be partially responsible and despite recent increases among Manufacturing Production, the latest ZEW survey highlighted a weakening outlook in Germany and raised concerns as investor sentiment deteriorates. That said, overall growth in Europe still remained in positive territory during the first quarter, with GDP increasing by 0.1%, replicating the previous quarter. Lower energy costs, easing supply constraints and a robust labour market helped to support moderate growth, which has encouraged the European Union to upgrade their overall growth expectations for this year. The EU now think that the region’s growth will reach 1% during 2023.  

Looking ahead, next week is all about the latest PMI’s for the region, which should show signs of further improvement, and may help to support the single currency, assuming that the dollar plays ball of course.