Pound Sterling remains on backfoot on surprisingly soft UK Inflation
- Pound Sterling drops sharply as UK inflation softened sharply in November.
- UK’s monthly headline inflation surprisingly contracted by 0.2%.
- Investors may raise bets in favour of early rate cuts by the BoE.
The Pound Sterling (GBP) fell sharply after the United Kingdom’s Office for National Statistics (ONS) reported a significant decline in inflation in November. The ONS reported that lower fuel prices were major contributor to a sharp decline in price pressures.
The GBP/USD pair has been heavily dumped as a more-than-anticipated decline in the UK Consumer Price Index (CPI) increase bets for early interest-rate cuts by the Bank of England (BoE). After the release of the UK inflation data, Chancellor Jeremy Hunt commented that inflationary pressures have been removed from the economy. Meanwhile, UK Prime Minister Rishi Sunak is set to meet his promise of halving inflation to 4.3% by the year-end.
While UK inflation has declined more than expected in November, BoE policymakers are expected to hold a stance for keeping interest rates higher for longer. Price pressures in the UK are still the highest in comparison with other developed economies, which would force BoE policymakers to call for rate cuts later than other major central bankers.
Daily Digest Market Movers: Pound Sterling drops after soft UK CPI data
- Pound Sterling faces an intense sell-off as the ONS has released a softer-than-anticipated inflation report for November.
- Monthly headline inflation contracted by 0.2% in November, against expectations of 0.1% increase. Annual headline inflation grew at a slower pace of 3.9% against expectations of 4.4%. Headline inflation has grown by 4.6% in October.
- The annual core inflation, which excludes volatile food and energy prices, softened to 5.1% versus the consensus of 5.6% and the former reading of 5.7%.
- Monthly Producer Price Index (PPI) for input and output have contracted 0.3% and 0.1%, respectively, less than what markets expected.
- This indicates prices of goods at factory gates fell, likely due to a decline in domestic and external demand.
- Despite the soft inflation report, the Bank of England is expected to keep interest rates restrictive for a more extended period.
- BoE Deputy Governor Sarah Breeden emphasized keeping the policy restrictive to keep price pressures in check.
- While asked about guidance on interest rates, Breeden said "I have no pre-determined policy path in mind."
- On Monday, BoE Deputy Governor Ben Broadbent also stressed keeping interest rates higher for a longer period. Broadbent highlighted the need for more evidence to confirm that inflation is in a clear downtrend.
- Later this week, investors will focus on November's UK Retail Sales data. According to the estimates, this measure of consumer spending grew by 0.4% on a monthly basis, against a 0.3% decline in October.
- Meanwhile, the US Dollar Index (DXY) turns sideways near 102.00 after a slight decline on increasing rate cut expectations by the Federal Reserve (Fed).
- The DXY US Dollar Index failed to find a firm footing despite Atlanta Federal Reserve President Raphael Bostic criticizing any urgency of interest rate cuts. Bostic added that the central bank must ensure that inflation returns to 2% given that the economy is resilient.
- This week, investors will focus on the US core Personal Consumption Expenditure price index (PCE) data, which will be published on Friday.
- Per the preliminary consensus, monthly core PCE is expected to grow at a steady pace of 0.2%. The annual core PCE is seen softening to 3.3% against the former reading of 3.5%.
Technical Analysis: Pound Sterling tests Tuesday's low
Pound Sterling surrenders its entire gains generated on Tuesday after the release of the softer-than-projected UK inflation data for November. The GBP/USD pair trades inside Tuesday’s range but is expected to extend its correction towards the 20-period Exponential Moving Average (EMA), around 1.2600.
The Relative Strength Index (RSI) (14) trades inside the 40.00-60.00 range, which suggests a consolidation ahead.
BoE FAQs
What does the Bank of England do and how does it impact the Pound?
The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).
How does the Bank of England’s monetary policy influence Sterling?
When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.
What is Quantitative Easing (QE) and how does it affect the Pound?
In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.
What is Quantitative tightening (QT) and how does it affect the Pound Sterling?
Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.
Author
Sagar Dua
FXStreet
Sagar Dua is associated with the financial markets from his college days. Along with pursuing post-graduation in Commerce in 2014, he started his markets training with chart analysis.
