The pound has continued its sideways trend after a week of mixed data. Traders can hope for Wednesday’s release of CPI figures to shake things up. Despite slow economic growth, the UK continues to face high inflation. This makes it particularly difficult for the government to address its budget issues and will likely keep the pound under pressure.
Last week, the UK’s monthly GDP for August came in at 0.1%, which is higher than the -0.1% of the month before. However, July’s figure was revised lower into negative. Putting the two months of data for Q3 that we have so far, the British economy is essentially flat. This makes rising inflation particularly troublesome.
What to Look Out For
The Headline September UK CPI is expected to rise to 4.0% from 3.8% a month earlier. Rising energy prices are attributed to the gains, but so is the cost of groceries. Retail prices are projected to rise to 4.7% from 4.6%. Meanwhile, the September core inflation rate, which is more closely followed by the BOE, is projected to rise to 3.7% from 3.6% in August.
According to the BOE’s projections, inflation is expected to rise through the latter half of this year, before declining in 2026. However, it is hard to make the case for cutting rates while inflation doubles the 2.0% target. If inflation remains elevated, the market might continue to discount further easing from the BOE.
How the Pound Will React
Typically, the prospect of higher interest rates would support the pound. This means that investors in UK securities can expect a higher return, which motivates them to buy pound-denominated assets. But, within a stagflationary environment, investors might be shy about investing in the UK as their investments could be at risk. Higher inflation could lead to the pound weakening instead of strengthening.
Slow growth usually means the government initiates stimulus measures that raise inflation. In the UK, those stimulus measures have to be paid for with higher taxes, which also raises inflationary pressure. If inflation remains elevated and potentially rises above the interest rate, then the real return on investments in pound-denominated assets could turn negative. That could prompt investors to pile out of the pound into other currencies and weakening cable.
What Will the BOE Do?
Economists have insisted that inflation in the UK is transitory until now. Even the BOE itself believes it will go down soon. But if CPI keeps exceeding the BOE’s projections, it will likely affect monetary policy. Then, it becomes an issue of whether the central bank prioritizes economic growth or price stability.
For forex traders, however, the choice might be immaterial. If the BOE lets inflation rise and prioritizes supporting the economy, the pound would likely be weakened. If the BOE keeps rates elevated and the economy sags, the pound would also likely weaken. It’s a very narrow policy gap in which the BOE can push the pound higher. And that might have more to do with what’s actually in the Budget. The pound might be on hold for another month until traders get answers.