The UK CPI data for August rose to its highest level since February, which helped push the pound above $1.32, albeit for a brief period. The pound is the one of the top performers in the G10 FX space post the CPI surprise this morning.
Why higher inflation could be here to stay
UK prices were driven higher by cultural, recreational, transport and clothing prices, which suggests that price gains were fairly broad-based last month. Slower price gains compared to a year ago were recorded for telecommunications, household goods and furniture. The jump in prices in August also coincided with the nadir for GBP/USD, which fell 11% between April and mid-August. Thus, we could see a few months’ of higher inflation due to the delayed impact of a weaker pound pushing up consumer prices.
Why rising CPI does not automatically mean rate rises
While we believe that the outcome of this summit will have a large impact on the immediate direction of the pound, we would also point out that today’s rise in CPI is not that good for the UK consumer. Real wages, when adjusted for inflation, have tumbled to -0.1%, as wage growth inc. bonus had been 2.6% in the three months to July. It is slightly better when you exclude bonus payments then real wage growth is currently 0.2%. However, rising prices erodes spending power, which could ultimately, make the BOE cautious about raising interest rates at too fast a clip.
Where next for the BOE?
The impact of the higher CPI data has seen a modest rise in expectations for a February rate hike from the BOE to 1%. The market is now pricing in a 31.2% chance of a hike, up from 24.7% a week ago. This is a significant increase, and it could rise further if today’s informal Brexit summit between Theresa May and EU leaders bears fruit regarding a Brexit deal for the UK.
Why the EU summit is more important than fundamentals
The noise leading up to the summit has been pound positive, with reports that the EU will give the UK a favourable deal and drop some demands regarding the Irish boarder issue, this has also driven the pound higher in the last few days. However, we remain on the lookout for a “sudden” shift in tone from the EU and a not-so-favourable outcome for the UK from this summit. If this happens, and if the prospect of a “no-deal Brexit” comes back onto the table, then we would expect the pound to come under pressure in the latter part of this week.
Momentum on the side of GBP bulls
However, from a technical perspective the pound is looking strong. GBP/USD broke above the top of its daily Ichimoku cloud yesterday at 1.3070, which suggests that momentum is positive for sterling leading up to this summit. GBP is also supported by a strengthening of the yield spread between the UK and the US, which now sits at -1.4%, at the end of July this stood at -1.7%, and the narrowing of 30 basis points is helping to prop up the pound at a fundamental level.
For now, GBP/USD is backing away from 1.32, as the market digests the impact rising prices could have on the UK’s fragile economic rebound. There could also be profit-taking ahead of tonight’s EU summit. As we have mentioned in recent notes, the future of the pound is dependent on the outcome and tone of this EU summit, and if there is positive news then GBP/USD bulls may have the guts to test the air above $1.32 once more.