Persistent UK Inflation Forces the BoE’s Hand– Sterling Update

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

GBP

BoE governor Andrew Bailey admitted this week that UK interest rates may need to stay higher for longer than had been expected, as persistent UK inflation forces the BoE’s hand. Speaking at the ECB’s annual conference in Portugal, Bailey highlighted market-implied expectations for future BoE rate hikes, saying ‘the market, I don’t think, thinks we’re nearly done at the moment. They’ve got a number of further increases priced in for us.’

Bailey is spot on, with the latest estimates predicting a new BoE terminal rate of around 6.25%, with some banks recently extending that to around 6.5%. Gulp. As we have highlighted previously, the positive impact to currencies from higher rates starts to erode considerably if recession risks increase substantially, and that is part of the reason why the pound is struggling to run up a down escalator in flippers at present. GBP/USD has now fallen by around 1.5% from the peak of 1.2840 just ahead of the last BoE meeting. However, were the dollar to resume its recent downtrend, then the pound could still be dragged higher given that the dollar side of the pair is still the most powerful draw over time.

Incoming data has hardly helped to improve sentiment, with news this week that leading supermarket Asda’s latest income tracker suggests that over 40% of UK households are not earning enough to cover their weekly expenses. The data also confirmed how much sticky inflation is impacting spending power, with those households now suffering an average shortfall of around £42.50 every week. Of course, the survey was conducted before UK rates were raised by 0.5% to 5% last week. The latest UK growth data was also released earlier this morning (Friday), with growth increasing by 0.1% during the first quarter of this year, and 0.2% on an annualised basis over the same period. In other news, the latest Nationwide House Prices confirmed an annual 3.5% decline in prices during June, with a slight (0.1%) increase over the past month. Time to batten down the hatches.

EUR

The ECB received a pleasant surprise on inflation from Spain of all places yesterday (Thursday), with news that Spanish inflation has fallen to 1.6% on an annual harmonised basis during June. That is an impressive decline indeed. The welcome decline makes Spain the first major European economy to see its inflation level fall to below the ECB’s 2% threshold since the beginning of the Ukraine war. This time last month, that figure was up at 2.9%, and the last time Spain’s inflation was down here was roughly two years ago. The big declines came among fuel, electricity and food prices.

The government have played a big part for Spain, issuing fuel subsidies and policies that erased the link between domestic electricity prices and wholesale gas prices, which clearly had such a staggering impact on inflation for the rest of Europe. However, Spain is lucky, given that it relied far less on Russian gas imports, and has an abundance of solar and wind power. As we often say, core inflation is another bestia altogether, and whilst still on the decline, remains at around 5.9%.

It was not such a sunny day for German inflation, which increased by 0.4% over the past month and rose considerably from 6.3 to 6.8% on an annual basis. Key Regional inflation is released later today (Friday) and is also expected to have edged slightly higher over the past month. The striking differences among inflation in the region highlight the increasing problem for the ECB. Speaking this week, Christine Lagarde remained particularly hawkish on the prospect for further interest rate rises,

with another 25bps move expected next month. However, Lagarde did admit that the ECB are now moving closer to a potential pause.

As for the Euro, overall, the single currency has also witnessed a fairly flat week, with EUR/USD declining slightly to just under 1.0900. Tellingly, there has been no collapse. GBP/EUR also declined below 1.1600, confirming that the single currency had a slight edge over the pound.