With interest rate policy one of, probably the major driver in the currency market, inflation data is key. The main tool to control inflationary pressures is through tighter monetary policy; that is to say, by raising interest rates. A high inflation figure increases the likelihood of an interest rate rise, or at least brings forward expectations of such a rise.
Today’s UK inflation figure for the month of May came in at 4.5% y/y, the same figure as the previous month (though prices rose by 0.2% on the month). This was in line with median forecasts and as such, failed to trigger any major sterling moves.
In fact it was the rumour of a weaker figure (4.3%), which surfaced in the half hour leading up to the 9:30am announcement and moved the markets the most. Sterling fell 40 pips or so against the dollar and 30 pips or so against the euro as suspicions mounted. A weaker figure would really have eased the pressure on the MPC to contain inflation through an interest rate rise, and sterling would probably have sold off quite badly.
The 4.5% does little to change market expectations of a rate rise, which remain delayed until 2012. The MPC have expressed that they see UK inflation hitting and perhaps exceeding 5.0% in coming months. They have also repeatedly confirmed (with a couple of exceptions) that UK growth is too fragile to accommodate an interest rate rise. Indeed, figures from the UK economy have been extremely disappointing of late, and we look set to learn of another poor quarter of growth.
Some brave forecasters are betting on a November UK rate rise, predicting inflation will head too high for the MPC to keep sitting on their hands. We just can’t see this happening, we are probably more pessimistic than consensus, and are looking to the second quarter of 2012 for a UK hike.
Where does this leave sterling? Well, broadly unchanged. We still remain in wait for decent growth figures, which are unlikely to come this week. UK retail sales are due out on Thursday, and are expected to show a contraction after April’s bumper month. Sterling has enjoyed a strong start to the week, but it could well come under pressure in coming sessions.
Richard Driver
Analyst – Caxton FX
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