Forex Trading Library

 UK Inflation: Time for the BOE To Throw in the Towel?

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All eyes in the cable trading space will be on the release of UK inflation figures to be released tomorrow. After the latest employment data, there has been renewed focus on the outlook for price changes. The BOE is one of the few major central banks that are seen potentially in a position to raise rates, given how high inflation is. But a miss on the data could cause a rapid shift in the other direction as the economic situation in Britain begs for rate cuts.

Earlier today, the ONS released what could be best described as a mixed bag of employment data. Individual data points were both supportive and against inflation, with signs of better economic conditions offset by indications of economic troubles. All-in-all, though, it appears the market thinks the result was negative, since the stock market fell and the pound gained. That leaves the impression that traders are setting up for the possibility that inflation will be higher than anticipated tomorrow.

Making Heads and Tails In the Dark

UK wages slowed their growth pace to 7.9%, but investors had been expecting an even faster deceleration to 7.4%. On top of that, when factoring in inflation, real wages actually grew. That might be a positive trend for consumers, since they’ll have more money in their pockets. But, that makes the situation more difficult for the BOE, because it implies more inflationary pressure.

The conundrum for the BOE is that success in bringing down inflation is leading to more inflationary pressure from demand. If wages are still rising, but inflation is falling, it means the BOE’s efforts are having a bigger effect on other areas of the economy. It also means the BOE can’t ease up on the fight against inflation, because higher wages imply latent consumer demand, and any cut in rates could yield a flair-up in inflation. For that reason, the BOE might shift its focus towards normalizing the employment market.

The Upcoming Data in Focus

The figure that will likely get the most media coverage is once again probably not going to be the one most capable of moving the markets. Headline annual inflation is expected to drop dramatically to 4.9% from 6.7% prior, thanks mostly to the hike in energy prices rolling off the measuring period. While a substantial improvement, it has been widely expected by markets, and still is well above the BOE’s 2.0% target.

What investors are more likely to focus on is the core rate, which doesn’t include energy or food costs. That’s seen falling at a much less auspicious pace to 5.6% from 6.1% prior, suggesting inflation pressure is still strong. But, what could be a sign of relief is that the monthly rate is expected to drop to just 0.2% compared to 0.5% prior.

What Could Be the Reaction

The last vote to keep rates paused at the BOE being at 6-3. There are still considerable chances that if inflation overshoots, two votes might switch sides and that could equal a rate hike at the next meeting. The markets appear to be discounting that possibility, so a large beat in inflation figures could give the pound a substantial push.

On the other hand, analysts are already talking about when the next rate cut will happen, with Morgan Stanley yesterday being the latest. They suggested the first cut could happen as soon as May, given the underperformance in the UK economy. Seeing as the market is positioning itself towards expected easing, a surprise to the downside would have to be large in order to substantially hurt the pound.

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