Last week’s inflation figures out of the UK radically shook up expectations for rate cuts this year. The views of the market and economists opened a gap, suggesting there is room for the currency to move. The pound stayed relatively steady despite the surprise in the data, an indication that the market is waiting for more to confirm their suspicions.
That extra data that could move the needle on sterling might come out on Tuesday, with the release of the UK Jobs Numbers. That’s because the BOE has zeroed in on strong wage increases, particularly in the service sector, as being a problem to bring inflation down to target. As long as the labor market remains “tight”, the BOE might keep rates up. But, if there is another surprise to the downside, the markets might have an opportunity for a substantial move to weaken the pound.
Why the Trepidation
Last week, it was reported that UK inflation not only missed expectations for it to rise, but it actually went down. More importantly, the core rate – which is closely followed by the BOE – fell faster than expected. It was through that core CPI would come in at 3.4%, just a bit lower than the 3.5% in November. But it dropped substantially to 3.2%. That’s above the target, to be sure, but it’s a sudden move in the right direction, somewhat ahead of schedule.
What some analysts were quick to pounce on was a section of the report that showed services inflation falling to 4.4% from 5.0% reported a month earlier. That services component has been the big thorn in the thigh of the BOE, so it could be an indicator that the tide is finally turning in the inflation battle. But, those same analysts were also quick to point out that this is just one report so far, and it could be an outlier as December data is influenced by holiday spending (and British patrons, it seems, were loath to open their pocketbooks last month, as the Christmas trading updates of leading firms demonstrate).
Seeking Confirmation
After the data release, analysts said that a rate cut at the next BOE meeting at the start of November was a real possibility. But, the markets didn’t go so far as to actually price it in. Before the data, markets expected 50 bps of easing out of the BOE this year. After it, that bumped up to 70 bps, or around three rate cuts. Economists went even further, with a Reuters poll after the data showing that a majority expected four rate cuts (100 bps) before the year was out.
The missing element could be the labor situation, as inflation is seen unlikely to fall precipitously if wages are still growing at well above target. So, if markets see a sudden drop in average earnings, or other clear signs from the the UK Jobs Numbers indicating a loosening jobs market, then they could move to agreeing with the economists, pricing in more rate cuts and finally weakening the pound. But if the jobs data matches or even exceeds expectations, then the market could go back to expecting just two rate cuts and keep the pound steady for now.
What the Data Could say
Markets expect that the unemployment rate in the UK will stay unchanged at 4.3%. A bump up in this figure by a couple of decimals could be confirmatory of the easing labor conditions. But it could also spook investors who are worried that economic underperformance is putting undue strain on government finances, and occasion further fleeing from pound-denominated assets.
The main indicator that traders might be looking at is the average earnings including bonuses, which is expected to accelerate to 5.5% from 5.2% prior. That implies that inflationary pressures remain in place, with the BOE likely to be more hesitant to ease. A substantial miss here could be the key to unlocking further weakness in cable.
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