Monthly UK headline inflation figures are released tomorrow. Another sharp increase in consumer prices is likely to heighten pressure on the Monetary Policy Committee (MPC) to replicate last week’s European Central Bank rate rise decision. The market’s forecast suggest that last month’s rate of 4.4% will be maintained but with commodity prices regularly hitting record highs, we find it hard to believe that UK inflation levels for March will not have increased, if only by 0.1% or 0.2% m/m.
Sterling is likely to benefit in the near-term from any rise in UK inflation as speculators set their sights on a Bank of England rate rise at next month’s meeting. Considering the extra stress that higher prices put on consumers, it might be surprising that sterling would benefit from higher inflation. But with Central Bank interest rate policy continuing to dominate major currency trends, economic fundamentals are have become of less importance from the market’s perspective. That said, the market is somewhat more responsive to positive UK economic data than to most other economies, because the MPC has made it clear that it’s loathe to raise interest rates until UK growth shows a firm foothold. The most reliable evidence for this growth will come when first quarter GDP is announced at the end of this month.
The MPC has given indications that 5.0% UK inflation could be a benchmark which may finally force its hand with regard to a rate hike. Bearing in mind current levels, expectations of a May rate rise could therefore be over-optimistic. It would take quite a significant jump to reach the 5% benchmark this month so we believe the MPC will be willing to continue to delay tightening policy.
The market currently has a 0.25% UK interest rate rise fully priced in for August. We are still set on June.
This is how we see tomorrow’s inflation figures effecting BoE rate rise expectations...
Inflation remains unchanged at 4.4%: August – probable July/June – possible May - highly unlikely.
Inflation rises to 4.5-4.6%: August – possible June – probable May - unlikely.
Inflation rises to 4.7% or above: August – highly unlikely June – probable May - possible.
In terms of sterling’s near term outlook – ie next few days – sterling should receive a boost if a number above 4.4% is recorded. However, the effects are likely to wear off by the end of the week with the strength of the single currency showing no signs of diminishing.
Richard Driver
Analyst – Caxton FX
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