Can the pound benefit from dwindling inflation pressure?

The plethora of UK economic data this week combined with the ongoing Brexit negotiations and political backstabbing in Number 10 should make for a lively week for sterling. Inflation data, retail sales and public sector finances are all released this week, which could give us a good idea whether the UK economy has picked up in the second quarter, or if we can expect another sub-par quarter for UK growth. Either way, this week’s data could be a key driver of UK asset prices this week.

When weak data is good

Inflation will be watched closely for signs of a further squeeze on the UK consumer, although it is looking like inflation pressures could fall as last year’s post-Brexit decline in the pound starts to wash out of the index. The market is expecting headline and core inflation rate to remain steady at 2.9% and 2.6%, respectively. If the estimates are correct then this would be the first time that the headline rate hasn’t increased since March, which could ease fears about the squeeze on the UK consumer, and may actually boost sterling, as it could brighten the outlook for retail sales and consumption in the coming months.

Are UK shoppers back in force?

To assess the impact of the UK economic data on the pound and the FTSE 100, you can’t look at Tuesday’s inflation data in isolation, it is also worth taking a look at retail sales, which are released on Thursday. The market expects a decent turnaround in retail sales, the June data is expected to rise 0.5%, from a 1.6% drop in May. This could boost sales over the quarter, with some analysts expecting retail sales over the three months to June to rise by a healthy 1.5%. Analysts are hoping that the better weather will boost sales for last month, but there are some downside risks, such as weak wage growth, which could make these forecasts look overconfident when the data is released later this week.

While it seems logical that inflation could pull back later this year, as the effects of 2016’s rapid decline in the pound start to fall out of the index from this month, we are less confident that retail sales will be as strong as the market predicts, the annual rate is expected to rise by 2.5% in June. Weak service sector PMI and weak sales at John Lewis, the department store, also make us cautious, even though we acknowledge that the BRC sales index was above consensus for June at 1.2% vs. expectations for 0.8%.

Don’t forget about Brexit

While the economic data is a key driver of the pound this week, the ongoing Brexit negotiations are also worth watching. The pound has been falling as we lead up to the UK economic data releases, GBP/USD is down 50 pips on Monday after surging to its highest level since September on Friday. This is partly due to the recent stories on in-fighting in Theresa May’s cabinet that some investors’ are worried could make a successful Brexit negotiation harder to achieve. It is worth remembering, that the outcome of the Brexit process is still the key element that could shape the UK economic outlook for years to come. With David Davis and team already in Brussels this week for their second set of discussions with the Brexit negotiators from the EU, any sign of discord could send the pound into a tailspin once again.

The outlook for the pound

A very simple correlation analysis finds that GBP/USD is most sensitive to the UK economic data, compared to the other crosses, and the FTSE 100 maintains its negative correlation with the pound, it has been -0.33 since the start of this year. Thus, it is worth concentrating on cable if you are watching the pound ahead of the UK economic data. So, where could GBP/USD go next? The technical picture is starting to look bullish. The inside bar from 2 weeks’ ago, has been followed by a large positive candle from last week, which suggests that the next move may be higher. Decent fundamental data could help the pound since the technical picture is also on its side. As we mention above, weaker inflation could actually be seen as positive for the pound, as it could boost consumption, and thus the economy, down the line. If retail sales are as strong as the market expects (we think they could come in below estimates, but still be a big improvement from May), then this could open the way for GBP/USD to rise towards 1.35. Also worth noting, GBP/USD has broken above the base of the weekly Ichimoku cloud, opening the way for a move to the cloud top at 1.3429, a key level of resistance.