Markets hope for softer inflation – Sterling Update

GBP

After last week’s sudden drop in the pound, with GBP/USD slipping from a top approaching 1.2500, to briefly testing support below 1.2000 earlier this week, the pound has stabilised over the latter part of the week, rising to 1.2200 at one point on Thursday. The broader pound has fared well, with GBP/EUR even managing to move above 1.1300 just yesterday. There has been a mixed bag of results amongst key UK housing price data, with the latest Halifax house price index implying a stabilisation of prices over the past month, which may be a reflection of softening yields at the long end of late, which has helped to reduce mortgage rates, albeit only marginally for now. However, ask surveyors and their latest measure of UK house prices tells a slightly different story, with the index actually deteriorating throughout January.

The latest UK growth figures have just been released this morning, and GDP declined by 0.5% over the past month, which was worse than the 0.3% drop estimated. However, it was not all bad news, as both Industrial and Manufacturing Production beat estimates, with the former increasing by 0.3% (-0.2% exp) and the latter flatlining (-0.2% exp). Total Business Investment also increased by nearly 5% over the past quarter (at4.8%), way ahead of the -1.9% expected.

Next week is a bumper one for UK data, with both consumer and producer price inflation set for release, coupled with the latest employment report and Retail Sales data, which collectively should give the BoE a much broader outlook on the shape of the UK economy, as they digest the impact (damage) of their cumulative rate hikes. As we have said before, the outlook on rates from the BoE looks uncertain, given a similar uncertain outlook for the UK economy. By way of example, the IMF think that the UK economy is likely to be the worst performing major economy amongst the major economies of the world this year, however, the National Institute for of Economic & Social Research (a think tank) will tell you that the UK economy is set to avoid slipping into a recession altogether. We always say that If you put twenty-four economists in a room, you will get at least thirty different opinions.

Back to the pound, and whilst sterling has bounced back with much aplomb throughout this week, the key inflation data is likely to set the tone for the pound’s fortunes through next week, as markets attempt to second-guess the BoE’s next move. On that note, the latest estimates call for a dip in headline inflation, with the chances of core inflation rising, given the lag effect on prices.

EUR

A week can be a long time in markets. This time last week, EUR/USD was sunning itself above 1.1000, the ECB were going to be hawkish for longer on rates, boosted by a recovery in economic activity in the region, and all talk was everything Euro-dominated being an outperformer. The single currency has certainly lost its shine since then, with EUR/USD slipping back below 1.0700 earlier in the week, and whilst much of that move has been down to a stronger USD, the more cautious tone from the ECB, coupled with some softening amongst key Euro area data releases, have played their part in the reversal too.

Amongst the data, regional Retail Sales slipped through December by 2.7%, and whilst a decline had been expected, the figure was worse than had been estimated. Whilst the ongoing impact of high inflation has clearly impacted consumer demand, there is a light at the end of the tunnel, and this week’s German inflation reading reflected a further decline from 9.6 to 9.2% (YoY) for the key harmonised index of CPI. Whilst softer inflation may be good for a country, is does not initially feed through to a stronger currency, given that it reduces the probability of imminent rate hikes.

Looking ahead, next week will see the release of the latest regional growth and unemployment as well as Spanish inflation (January).  As for the single currency, well much still depends on the ECB. They have already stated on many occasions (including this week) that they intend to hike rates by 0.5% at their next meeting, however, beyond that they will be assessing the cumulative impact to the economy, before deciding on their next move. Were the ECB to signal a pause, then further gains might be a bit harder to come by for the single currency.