GBP: Is inflation a game changer? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, notes that the UK CPI inflation has screeched past the Bank of England’s 2% target to register a stronger than expected 2.3% y/y rise in February and feeding the gains was the weak pound which not only accentuated the impact of higher food and energy prices but, by supporting rises in goods such as cars and computers, helped to lift core inflation to 2.0% y/y. 

Key Quotes

“The rise in the latter is the more worrying part of the inflation report. Higher inflation caused by GBP weakness is eroding real incomes and leading to overall demand.  While employment levels are strong, tight labour conditions have been unable to prompt much wage inflation and this is also suggestive of sluggish demand.”

“Currently, we see little risk that the MPC will be in any rush to hike interest rates.  Political uncertainty is likely to feed the Bank’s reluctance to act particularly if the EU push back hard against PM May’s proposals once the Brexit negotiations commence.  This uncertainty, however, could create additional cost push inflation if GBP’s decline extends.  We would therefore expect that the BoE could choose to step up hawkish commentary to control any further bout of weakness in the pound.  We expect EUR/GBP to head to 0.89 in the second half of this year.”