Pound Waits Reaction to Hot UK Inflation

Inflation in Britain is expected to continue rising, with the economy giving the BOE a little more room to continue its slow easing path.

An Expected Spike

Markets anticipate a sharp increase in headline inflation in the UK due to rising energy costs. However, they also expect the core rate to remain relatively stable, reinforcing expectations that the BOE will continue its "cautious" gradual easing of interest rates. Despite concerns that higher inflation could dampen consumer sentiment and weigh on growth prospects later in the year, in the first quarter, with higher prices contributing to an increase in monetary circulation.

The higher inflation is not seen as likely to impact the BOE's outlook, partly because the central bank expects the increase. In fact, the BOE not only expects inflation to remain above target for the remainder of the year but also to as high as 3.7% by September before declining towards the target. Meanwhile, the UK economy is expected to struggle, implying that the central bank will likely attempt to keep interest rates as low as inflation allows. As such, a lower-than-expected inflation print could have implications for the future BOE rate path.

The Data and Market Reaction

The headline UK inflation rate is expected to jump to 3.3% in April from 2.6% previously, well above the BOE's 2% target. Even though, it is still 6% higher compared to a year ago, as April is typically the month when utility companies adjust prices for consumers. This also explains why monthly inflation is expected at 1%, compared to 0.3% in March. Meanwhile, the core inflation rate is expected to tick up to 3.5% from 3.4% previously. Markets will also likely be curious about the impact on economic activity, with retail sales on Friday being a consideration for the pound, as shoppers are expected to have increased their spending by 3% over the last year, up from 2.6%.

The expectation that the BOE will be slow to ease due to high inflation has kept the pound relatively elevated. As the dollar has recovered over the course of the last year, the pound has kept pace, with cable largely trending sideways. Meanwhile, the euro has been losing ground. Due to Moody's downgrading of the US credit rating, the bout of ended up supporting the pound more than the euro. But this likely relies on expectations that the upcoming CPI data for the UK will make the case for the hawks at the BOE.

EURGBP Double Bottom Could Fuel Breakout

A double bottom pattern has formed in the EURGBP pair in the 0.8220-0.8240 area, sending the pair shy of 0.8769 to 0.8738, where prices reversed instantly at the 0.87 handle. The move now sits at the 61.8% retracement of the leg up at 0.84, with a failing support opening the door to 0.8315 and the bottom. Conversely, a bounce could see prices rise to 0.8475 and 0.85, with chances of reversal continuing to 0.86 and 0.8625.

Source: SpreadEX / EURGBP

Key Takeaways

The headline inflation in the UK is expected to come in hot due to rising energy costs and could fuel expectations for slower rate cuts by the BOE. Although this could support the pound, the central bank's “cautious” approach and relative stability in the core rate could limit the impact of the reaction, with markets also waiting for retail sales data on Friday for further clues from British consumers.