Headline Inflation Falls Below 8% – Sterling Update

Here’s the latest currency news from our partner Moneycorp, to help you find out what your money is worth.

GBP

Having rallied from under 1.2400 to over 1.3000 in the space of two months, GBP/USD hit the buffers this week, slipping back under 1.2850 by Thursday afternoon. Fuelling the turnaround was the latest UK inflation report. Headline inflation declined to a slightly more respectable 7.9% on an annual basis during June, having been predicted to have fallen from 8.7% previously, to around 8.2%. Remarkably, that is the first time that headline inflation has fallen to below 8% for over a year. That line is almost worth repeating.

There was also a slight beat for core inflation, which strips out food, energy, alcohol and tobacco, which dipped to 6.9% on an annual basis, from 7.1% beforehand. Aside from the big drop in the pound, the news also helped to shift future expectations for BoE rate hikes, with the key market-implied terminal (or final) rate shifting down from 6% to 5.75%. The moves were aided by a drop among key UK gilt yields. Despite the news on inflation, worries over a weakening UK economy persist, with recent data highlighting a drop in monthly GDP during May, declining by 0.1%, having risen by 0.2% in the previous month. However, that figure actually beat estimates of a 0.3% decline. The broad manufacturing sector is also feeling the pinch, with production declining by 0.2% over the past month, combined with a sharp 0.6% decline among Industrial Production.

There was some upbeat news from the consumer side on Friday morning, with confirmation that UK Retail Sales had risen by 0.7% during June, beating estimates of a 0.2% gain, and 0.1% previously. Annual declines have now trimmed to -1%, from -1.5% expected and -2.3% previously.

Whilst the UK economy has therefore somehow just about been able to avoid a dip into a recession so far this year, the outlook still remains fragile, and the improving inflation outlook could perhaps not have come at a better time for the BoE. The last (50bps) rate hike was made at the end of June, and so the latest inflation report will not have been influenced in any way by that big hike. Mervyn King, who was the BoE governor before Andrew Bailey, has been on the wires warning of a potential UK recession risk, were the BoE tighten by too much, which still seems a reasonable assessment. He suggested that the BoE have been ignoring money supply data.

In the meantime, the pound is still adjusting to a lower rate outlook, with GBP/EUR falling below 1.1500 for the first time since May. GBP/USD is another beast altogether, and whilst the knee-jerk selloff is understandable, the path forward is somewhat trickier to navigate, given the additional impact of the broadly weakening dollar.

EUR

Much the same as in the US, the ECB are fully expected to hike Euro area rates by 0.25% at next week’s meeting. Inflation may have moderated a tad, with regional harmonized CPI dropping to 5.5% from 6.1% previously, but much the same as every other major central bank, they will not rest until inflation hits their target level of 2%.

Despite this, a slight shift in language may be the first sign of a wavering ECB, with comments this week from the ECB’s Klaas Knot, who suggested that there may not be any further rate hikes beyond

this month’s expected 25bps move. Avid readers of our commentaries will be aware of Knot’s ongoing hawkishness, so when he said (on rate hikes) that ‘anything beyond July it would be a possibility, but by no means a certainty’ there is clearly a growing possibility that the ECB could soon be joining the ‘one and done’ club.

Therefore, what the ECB have to say next week is key and is likely to have a big impact on the single currency. Talking of which, EUR/USD rallied al of the way up to 1.1275, before consolidating earlier in the week, and dropping to a one-week low below 1.1150, as the dollar found some worthy support.