CPI gives GBP a boost, but it's only temporary

The pound has bounced this morning and made fresh highs of the day after CPI was stronger than expected. The October reading rose to 1.3%, the market had expected it to remain at 1.2%. Considering the Bank of England Governor Mark Carney was dovish in last week’s Quarterly Inflation Report and said that there was a risk that inflation could fall below 1% in the coming months, was he being too cautious?

Call of Duty helps boost the CPI

The Office for National Statistics, who produce CPI data, said the reason for the uptick was a smaller than expected decline in transport costs compared to a year ago, particularly motor fuels and air fares. Computer games were also the main contributors to the rise in price growth. The latest instalment of the smash hit Call of Duty was released last month, which may have added to the upward pressure on prices.

We believe that the recent jump in prices is a blip, and the downward trend in inflation will continue for the medium-term. The ONS data also revealed that food and motor fuel prices, which historically have been upward contributors to the 12 month CPI rate, are currently reducing prices by 0.3 percentage points. Thus, if the trend of weaker food and energy prices continues then we could see further declines in CPI in the coming months.

What does this mean for the pound?

GBPUSD bounced to fresh highs of the day post the CPI data, although it has lost some traction on the back of the bounce in EURUSD after a stronger than expected ZEW survey. We continue to think that the longer term outlook is for a weaker GBP; however there could be room for a short term bounce. Some key resistance levels to watch out for include: today’s high at 1.5669 then 1.5736 – a short term top from Monday.

The fundamental picture remains weak for the pound, so today’s jump could be temporary. Later this week there are two key event risks that could weigh on the pound. The first is the public finance data, which is expected to show another increase in our deficit; the second is the Rochester by-election on Wednesday, which could show another win for UKIP, which may increase political uncertainty in the UK merely 6 months before the next general election.

Elsewhere:

The pound isn’t the only mover worth noting in the FX world today. A stronger than expected ZEW survey from Germany has helped get EURUSD above 1.25. We expect EURUSD to stay within its most recent range between 1.2399 and 1.2578 – the 17th Nov high. We expect any upside in EUR will be capped as ECB members have come out in force recently to tout the possibility of further ECB easing. Yves Mersch was talking about it overnight, and even ECB President Draghi said that an expanded asset purchase programme could include government bonds. These pro-QE comments reinforce the contrasting stances between the ECB and the Fed’s monetary policy, which is EUR negative for the long-term, in our view.

Abe fights back

The yen is also in focus today. Yet again, Monday’s moves proved to be a false indicator. The yen looked like it was in recovery mode first thing, before USDJPY continued its march higher. Today USDJPY has been choppy on the back of Japanese Prime Minister Abe’s speech. The key points from his speech include: the sales tax hike scheduled for January 2015 has been pushed back 18 months, Parliament will be dissolved on 21st November and he has called for a snap election, although no date has been announced of yet. He has also ordered his ministers to start preparing for a new stimulus package after Monday’s data showed that the economy had fallen back into recession in Q3. Abe seems confident that his Liberal Democratic Party will win this election, so much so that he is already putting in place plans for his next term, which could see him in power until 2018.

The impact on the yen has been mixed. After some whipsaw action, USDJPY has settled lower on the back of Abe’s comments. However, we think this is temporary. The yen is a safe haven and tends to strengthen on the back of political uncertainty such as snap elections. However, once the market understands that Abe’s Liberal Democrats are likely to win the next election then the fact that Abe is promoting more stimulus and even loser monetary conditions should weigh on the yen. We believe that we could see back to 120.00/ 121.00 by year end.

Overall, domestic fundamentals have come back to the forefront of the FX market, and this has caused some deviation from the main theme out there: the strong dollar. However, we believe that the uptick in GBP, JPY and EUR will be temporary, and the stronger dollar theme will come back into play after these short term adjustments in the major dollar pairs.