Pound Sterling Jump on Upside Inflation Surprise Tempered

January 18, 2024 - Written by John Cameron

STORY LINK Pound Sterling Jump on Upside Inflation Surprise Tempered

The Pound jumped after the stronger-than-expected UK inflation data with fresh doubts whether a Bank of England (BoE) interest rate cut by May is realistic.

The shift in expectations underpinned the Pound, although the impact was offset to some extent by a further retreat in risk appetite as the UK FTSE 100 index posted a 6-week low.

The Pound to Dollar (GBP/USD) exchange rate spiked to highs of 1.2675 from just above 1.2600 before settling around 1.2650.

The Pound to Euro (GBP/EUR) exchange rate also jumped to 1.1650 before consolidating around 1.1640.

A key element across the board was a scaling back of expectations for interest rate cuts across all major economies.

The relative shifts in yields are likely to be limited, but weaker risk appetite will favour the dollar.

UK consumer prices increased 0.4% for December compared with consensus forecasts of 0.2%

The headline year-on-year inflation rate increased to 4.0% from 3.9% and above expectations of a further slight decline to 3.8%.

This was the first increase in the annual rate since February 2023.

The core rate held at 5.1% and compared with consensus forecasts of a decline to 4.9%.

According to ONS, chief economist Grant Fitzner said: “The rate of inflation ticked up a little in December, with rises in tobacco prices due to recently introduced duty increases.”

He added; “These were partially offset by falling food inflation, where prices still rose but at a much lower rate than this time last year.”

Producer prices data was more favourable with producer output prices increasing 0.1% on the year after a 0.6% monthly decline with input prices declining 2.8% over the year.

ONS’ Fitzner added; “Meanwhile, the prices of goods leaving factories are little changed over the last few months, while the costs of raw materials remain lower than a year ago.”

The principal focus will be the impact on BoE expectations.

According to MUFG; “the stronger than expected reading for both core and services inflation in December at 5.1% and 6.4% are disappointing and will discourage the BoE from beginning to cut rates sooner.”

Samuel Tombs, chief UK economist at Pantheon Macroeconomics noted that the inflation rate was still below the recent BoE forecast. He added; “Note too that its new measure of underlying services CPI inflation fell to 6.4% in Dec, from 6.5% in Nov.”

Paula Bejarano Carbo, associate economist at National Institute of Economic and Social Research (NIESR) added; “it is likely that this slight rise is more reflective of ‘noise’ rather than a genuine signal of a change in the declining trend of inflation.”

Nevertheless, she added; “That said, with services inflation rising slightly from 6.3pc in November to 6.4pc in December, as well as the possibly inflationary effects of recent geopolitical events, there is a risk that inflationary pressures may rise further in the coming months.”

RSM economist Thomas Pugh noted the huge increase in airfares for the month.

He still considered that inflation could be below 2% by May and added; “As a result, the door is still open to a first interest rate cut coming in May.”

ING also pointed to erratic moves across services; “The lesson here is not to react to one month’s worth of data on services inflation. But it is a reminder that the decline in services CPI will be gradual in the near term, and we don’t expect this to dip below 6% until at least March.”

ING considers that more tangible progress on services-sector inflation and wages, together with a muted fiscal package, will be needed to allow a May rate cut.

According to the bank; “For the time being, EUR/GBP can probably trade closer to 0.8550/8600 (1.1630 - 1.1695 for GBP/EUR) and it looks like the better dollar/softer risk environment can drag GBP/USD back to the 1.2500 area.

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TAGS: Pound Sterling Forecasts