Forex Trading Library

UK Inflation Complicates Expected BOE Hold

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Cable is in for a potentially rough couple of days with upcoming economic events. That is, unless a series of particular notes is reached that matches a lot of different expectations. All eyes are on the BOE rate decision on Thursday. But tomorrow is the release of May inflation, and if that comes out far enough away from expectations, it could throw the market reaction to the BOE into disarray.

The consensus for the rate decision is that it will likely be a hold, with economists pointing to the pending UK general elections and the central bank’s tradition to stay out of politics. The data isn’t pressing to the point of demanding a rate decision, at least in the unanimous view of economists. But economists are also very much of the opinion that a rate cut is imminent, and Thursday’s decision is a good opportunity to prepare the way.

The Wrinkle in the Expectations

The thing is, tomorrow’s data release is expected to show that UK headline inflation has come down to 1.9%, below the 2.0% target for the central bank. That’s also substantially below the 2.3% recorded in the prior month. Why no one is simply declaring the fight to bring inflation down over is that the majority of this drop is due to highly volatile elements, such as energy and food costs.

The Core rate, which is what the BOE focuses on when making its rate decisions, is seen staying well above target, though coming down substantially. The forecast is for core May inflation to be at 3.4%, down handily from the 3.9% of April. While certainly trending in the right direction, the consensus is that it is not quite close enough to the target to bring forward a rate cut. But if the result were to miss by a large enough margin, then markets could move to seeing a rate cut a day later.

Marking August on the Calendar

The BOE not only can cut rates before core inflation reaches target, but is widely expected to do so. That’s because the current rates are seen as ‘restrictive’, or slowing down the economy in an effort to bring down inflation. Rates could be lower and still help to lower consumer prices as long as they are heading in the right direction. That is, at least, the consensus among economists – including those at the BOE.

With the UK slowly coming out of last year’s technical recession, the pressure is on to make sure the central bank doesn’t prevent the economy from taking off by having rates too high for too long. So, if enough members of the Monetary Policy Committee (MPC) agree that it’s time to ease, then there could be a cut at any time. Headline inflation going below target could be one of those times.

Looking to the Vote Count

Unless inflation comes in different from expectations, the market is prepared for the BOE to signal that the meeting in August will see the first easing. Economists and the market are predicting one more cut after that.

But, if inflation is higher than expected, it could lead to the market dismissing that August cut. On the other hand, how many MPC members vote for a cut will also be seen as a gauge of the willingness to start easing. Last time it was 2-7, and now it’s a question of whether one or two more votes come in for easing.

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