The pound sterling quickly gave up its initial advance in a possible warning that markets may panic about continued inflation.
- The pound rose to its highest level against the euro since December after data showed that UK inflation came in well above expectations in April but quickly gave up the advance amid potential concerns that the UK is facing a unique inflationary problem.
- In the case of the GBP/USD currency pair, it moved upwards temporarily, towards the level of 1.2469, before moving back in its downward path, reaching the support level of 1.2360 at the beginning of Thursday's trading.
British bond yields rose after the Office for National Statistics reported a headline CPI reading of 8.7% in the year to April, down from 10.1% in March, but well above the 8.3% reading the market was looking for and above the Bank of England's forecast. Bond yields and the British pound initially rose in tandem as money markets revealed that investors had raised their bets for a peak in the Bank of England interest rate to 5.5% by the end of the year; This is after core CPI inflation read at 6.8% y/y, above expectations of 6.2%.
The pound sterling quickly gave up its initial advance in a possible warning that markets may panic about continued inflation. In short, the concern is that high inflation and interest rates will lead to a major economic downturn in the future, leading to a breakdown in the relationship between the pound and bond yields. For its part, the Bank of England has already raised interest rates to 4.5% in its efforts to control inflation, but evidence provided by the Office for National Statistics on May 24 suggests that Threadneedle Street policymakers may have significantly underestimated inflationary pressures.
Of particular concern is service inflation, which rose from 6.6% to 6.9%, as the bank stressed that it would closely monitor this figure as it gives clues about how local businesses and workers contribute to inflationary pressures. Accordingly, Victoria Clarke, chief UK economist at CIB Santander Bank, said that : “The picture is one of stinging inflation, as evidenced by broad momentum in the main components of service inflation.”
Sandra Horsfield, an economist at Investec, said that: “There is not enough good news in the April inflation data in the UK to stop the tightening.”
“This is a disappointing set of numbers that will cause more concern among MPC members that the process of The hoped-for inflation relief is not as decisive as expected,” she added.
The general rule is that bond yields and the pound will rise when expectations of a rate hike rise. However, we wrote at the beginning of the week that this may not necessarily be the case for much longer if the market begins to worry that the UK is facing a serious inflation problem. This is because inflation erodes living standards and business profits, seriously undermining the outlook for economic growth. The inability of the pound to sustain its initial gains may raise concerns that the British economy is facing a particularly acute inflationary problem.
Granted, the pullback in GBP hasn't been sharp (yet), and it could find itself supported, but the inability to really rally as this solid inflation wins is something to watch. However, there will be some comfort that UK headline inflation has eased sharply from last month when it was at 10.1%. Inflation grew by 1.2% in the month through April, which was actually a stronger monthly rise than the previous month's 0.8% and a solid beating of the 0.8% the market was looking for. The government and the Bank of England are hoping that Ofgem's announcement on Thursday that the energy price cap has come down too much will help put some negative pressure on the inflation outlook.
Regardless, the BoE will almost certainly not be able to abandon its rate hike cycle any time soon when it takes into account the CPI core inflation reading (which excludes energy and food and therefore gives a better understanding of UK inflation).
GBP/USD Technical Outlook:
According to the performance on the daily chart below, the price of the GBP/USD currency pair is still in the path of a recently formed descending channel, in light of the recovery of the US dollar against the rest of the other major currencies, despite concerns about the US debt ceiling. Comparing the future tightening between the Bank of England and the US Federal Reserve Bank will be a catalyst for both bears and bulls in controlling the performance of the currency pair. GBP/USD moved towards the support levels at 1.2340 and 1.2270, which will move the technical indicators towards strong oversold levels.
On the other hand, as I mentioned before, the bulls will not regain control over the direction of the GBP/USD without returning to the vicinity of the resistance levels at 1.2450 and 1.2560, respectively. Today, the currency pair will be affected by investor sentiment and the performance of global markets, as well as the announcement of the US economic growth reading and the number of weekly jobless claims.
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