UK inflation preview: A small beat may trigger a short-term GBP/USD selling opportunity

• UK inflation has risen from above the 2% target but is set to fall back in the data for May.
• Low expectations may result in an upside surprise, favoring the pound.
• The general trend remains to the downside and may provide a selling opportunity on GBP/USD.

Will the Bank of England get any closer to raising interest rates? The short answer is that Brexit uncertainty paralyzes any policymaking. Nevertheless, the BOE has a higher chance of maintaining the upbeat rhetoric on raising interest rates if inflation rises – and the pound is set to react to any positive surprise – in the short term. 

And this release will likely have a greater impact. The consumer price index data is timely as it comes out on Wednesday and the bank announces its decision on Thursday, making markets more sensitive to the figures despite the incessant political noise.

In turn, such a surprise may send GBP/USD higher – providing an opportunity to sell Sterling – as the general picture remains gloomy. Markets are concerned that Boris Johnson will become PM and lead the UK out of the EU without a deal – a scenario that could inflict severe economic harm.

What are the chances of such a surprise?

Expectations are low – headline CPI is forecast to drop from 2.1% year on year in April to 2% in May. Core CPI is projected to slide from 1.8% to 1.7%. A lower bar makes an upside surprise easier. Here is how it looks on the economic calendar:

Moreover, the FXStreet Surprise Index also implies that the data may beat expectations. Looking at data since January 2018, the surprise index has bottomed out at -35 and has now reached -17 – the highest levels since March. 

The recovery is U-shaped, indicating a turnaround rather than a "dead cat bounce."

Zooming out to the longer term and observing data since 2011, we can see additional patterns supporting an improvement in data.

We can see that -35 was not only the bottom in May this year but also May of 2018 – a double bottom. Moreover, the FXStreet Surprise Index broke above -25 that had capped it during the first fall last year and also the last one – and seems to have gained upside momentum.

All in all, we see a greater chance of an upside surprise in the all-important inflation figure than a downside one.

It is important to stress that if CPI beats expectations, a rally in GBP/USD may only prove temporary and a selling opportunity. While Boris Johnson may eventually oversee a smoother Brexit, his current rhetoric is worrying markets. Also, recent upbeat US data has pushed the US dollar lower and markets are awaiting the all-important Fed decision later that day.

And if headline consumer prices miss and fall below 1.9%, the pound may suffer as investors may speculate that the BOE may drop its intention to raise rates. 

Conclusion

UK inflation is a top-tier economic indicator that is set to impact GBP/USD. The general trend is to the downside due to political uncertainty related to Brexit and also the recent strength of the USD. The FXStreet Surprise Index points to an upside surprise – which may push the pound higher in the short term – providing a selling opportunity.

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