UK inflation preview: Did the pound's fall lift prices? Three scenarios for GBP/USD

Mercedes cars, Spanish wine, and French cheese are among the products that will likely see price rises and push inflation higher – even before Brexit has happened. The recent slump in the pound has been significant – and is related to fears of a no-deal Brexit – but will take time to reach consumers.

While sterling suffered a downward trajectory for several months, the loud crash came only in late July. Moreover, due to long-term contracts between producers, importers, and distributors – and their potential willingness to absorb the costs – prices will rise slowly.

Economists expect headline Consumer Price Index (CPI) to slow down from 2% in June to 1.9% in July. Core CPI, which excludes volatile items, to remain unchanged at 1.8%.

The Bank of England's target is 2% annual inflation, and it has hit its goal remarkably well in recent months. Due to significant wage rises – which are up 3.7% in June – real wages are on the rise, and it may create inflation down the road. The BOE has expressed its intent to raise interest rates and stay ahead of the curve. 

But then there's Brexit.

The high level of uncertainty surrounding the UK's exit from the EU has been paralyzing policymaking at the bank. Governor Mark Carney and his colleagues are assuming a smooth Brexit, but the chances are diminishing under prime minister Boris Johnson. 

For the sake of trading GBP/USD under the BOE's optimistic assumptions. In this case, higher inflation raises the chances of rate hikes, and lower price changes diminish these chances.

Here are three scenarios for trading the figure.

1) Within expectations – GBP/USD wobbles

If headline CPI rises by 1.9% or surprises by remaining unchanged at 2% – traders will look for clues from other figures such as core CPI and perhaps monthly changes for direction.

However, moves will likely be limited as the general picture will have remained unchanged – inflation is within the target, and Brexit uncertainty looms. Without any positive earth-shattering development around Brexit, GBP/USD may lean lower – following the general trend.

2) Below expectations – GBP/USD falls

In case inflation slows down despite a potential rise in import prices – it will serve as a sign of weakness for the UK economy.

GBP/USD may lose ground as disappointing economic indicators will have joined concerns about exiting the EU. Nevertheless, it will probably take more than a deceleration to 1.8% to have a long-lasting impact. Brexit headlines may take over after a short time.

3) Above expectations – GBP/USD temporarily advances

It would take a CPI rise of 2.1% or perhaps only 2.2% to trigger an unusual upward movement in GBP/USD. As mentioned earlier, the trend is to the downside, and only a leap in inflation would boost expectations for a BOE hike – and a consequent rise of the pound. 

However, it would also go to show that sterling's weakness is already reaching consumers – eroding their real wages. And that would be a mixed blessing for the economy. 

Conclusion

UK inflation has likely dipped to 1.9% in July. A downside surprise would likely push the pound lower while a significant upside surprise would be needed to push it higher. The impact of the recent sterling slide is central to this report – yet Brexit headlines are dominant and may limit the reaction.