Pound edges higher as inflation jumps to four year high

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Sterling made another march towards the physiological 1.30 level against the US Dollar on Monday, with the latest trading data showing that bearish bets on the currency had fallen sharply since Theresa May called for a snap General Election in June.

ata late on Friday evening showed that currency traders had slashed their net short positions to the lowest level in a year this month and by the third most on record. Investors have turned increasingly optimistic about the prospects for the Pound since May called a snap election, with the Conservatives overwhelmingly expected to gain a much stronger majority vote next month.

The Pound was given a boost this morning, albeit short-lived, following the release of the latest inflation data which showed that consumer prices in the UK jumped by the most in four years in April. Headline inflation increased to 2.7% year-on-year, comfortably above March’s 2.3% print and much higher than the Bank of England’s 2% target (Figure 1).

Figure 1: UK Inflation Rate (2014 – 2017)

A weak Sterling following the Brexit vote has caused import prices to rise and sent inflation sharply higher. The Bank of England has attributed this inflation bounce entirely to the depreciation in the Pound and while policymakers have claimed they will look through higher prices when deciding on policy, we think there is a limit as to how high inflation will go before the discussion of higher rates is back on the table.

Away from the UK, the Euro continued to surge higher off the back of last week’s disappointing inflation data out of the US economy. Market pricing for an interest rate hike by the Federal Reserve has fallen from 100% to closer to 90% since the release and we now only expect three hikes in the US this year rather than four.

Major currencies in detail

GBP

The Pound continues to trade just shy of the 1.30 resistance level against the US Dollar, with Sterling bulls reluctant to take the currency above this level following last Thursday’s Bank of England meeting. It would likely take a significant upward surprise in this week’s inflation or labour data in order to break this level, which is currently looking more like a top.

Next on the docket in the UK will be tomorrow’s labour data. Earnings and unemployment are both expected to remain broadly unchanged.

EUR

The Euro rose back above the 1.10 against the US Dollar on Monday to a fresh seven month high as investors began dialling back their expectations for interest rate hikes by the Federal Reserve. Other than that yesterday was a very quiet session in the Eurozone with no economic releases of note.

GDP numbers for the first quarter will be released in the Eurozone this morning with growth expected to come in unrevised at a healthy 0.5% quarter-on-quarter. In the absence of any major surprises, the Euro is likely to be driven by events elsewhere today.

USD

The Dollar continued to trend lower yesterday, with last week’s underwhelming US inflation data and a bounce in commodity prices driving the greenback lower.

A new arrangement between OPEC and Non-OPEC nations to cut production until March 2018 helped lift oil back above $52 a barrel, causing investor to buy commodity dependent currencies and sell the Dollar. Monday’s New York Federal Reserve barometer of business activity was also disappointing, with the index slumping to -1.0 from 5.2 in May.

Second tier housing data will be the order of the day in the US this afternoon, with building permits and housing starts set for release.