Sterling rose slightly versus the euro and the dollar after data showed British inflation returned to the Bank of England’s 2% target in May for the first time in nearly three years.
The drop in annual consumer price inflation from April’s 2.3% reading was in line with economists’ median expectation in a Reuters poll and marks a sharp decline from the 41-year high of 11.1% reached in October 2022.
The euro dropped 0.04% to 84.46 pence against the pound from 84.48 pence right before the data. Sterling was up 0.05% against the dollar at $1.2713, having traded at $1.2704 earlier.
Markets are pricing in an about 50% chance of a first-rate cut by August and almost half a percentage point in monetary easing in 2024.
The BoE meets on Thursday to discuss interest-rate policy but is not expected to make any changes.
Pound Sterling Rallies Against Euro and Dollar: Services Inflation is Still Too Hot for the Bank of England
The British Pound rose after the UK reported another strong services inflation print, although the headline CPI inflation rate hit the Bank of England’s 2.0% target.
The GBP/EUR exchange rate lifted to 1.1860 after the ONS said the CPI services annual rate eased from 5.9% to 5.7% in May, but this was above the consensus expectation for a fall to 5.5%.
Money markets show investors lowered expectations for an August interest rate cut at the Bank of England as a result. OIS pricing shows expectations have slid to around 36% in the wake of these data, from around 55% the day before.
The British Pound gained ground on the US Dollar, reaching a new exchange rate of 1.2727. This rise is likely a response to recent adjustments in market forecasts. Analysts, like Arno Venter of Capital Edge Advisors, suggest the stronger Pound could be due to higher inflation in the UK’s service sector (CPI data).
The good news for UK consumers and businesses, however, was that the UK’s annual inflation rate finally fell to the Bank of England’s 2.0% target. May’s month-on-month figure reading was 0.3%, which is below the 0.4% the market was looking for.
Core CPI inflation was flat at 3.5% year-on-year, which is also what the market was looking for, so it won’t be a market mover.
Although the fall in headline inflation to 2.0% will be welcomed, most economists agree inflation will creep up again over the coming months because services inflation is still too high.
As the ‘base effect’ of previous price rises falls out of the annual comparison, the sticky services print could mean inflation refuses to stay around 2.0%. This is why the Bank of England will not cut interest rates as early as tomorrow’s meeting.
The key question for currency markets now is how these inflation figures impact the odds of an August rate cut.
Two members of the MPC voted for a cut already in the last meeting, and we reported on Tuesday that if one member – Dave Ramsden – withdrew his vote, the Pound would rise.
These inflation numbers could mean Ramsden sticks with his vote for a cut, and there is a risk others on the Monetary Policy Committee join him and Swati Dhingra.
If this is the case, the odds of an August cut would rise, likely resulting in a softer Pound heading into the weekend.
“Finally! UK inflation fell to 2.0% in May, hitting the BoE’s target,” says Julian Jessop, an economist at the IEA. “This was widely expected but still good news, and should make it much easier for more MPC members to join the two – Swati Dhingra and Dave Ramsden – who are already voting for a cut.”
Nevertheless, caution will be abundant amongst other members of the MPC, as the Bank will have to address the sticky services inflation print and acknowledge that headline inflation could well creep higher again over the coming months.
Such caution would likely limit the scope of any GBP weakness and offer downside protection.
Food prices contributed the largest downward contribution to the change in annual inflation between April and May, while motor fuel prices contributed the largest upward contribution.
“Services inflation was a significant 0.4pp higher than the BoE had expected. This, along with strong wage growth and election-related near-term economic uncertainty, is likely to keep the BoE on hold when it announces its monetary policy decision tomorrow,” says Marco Valli, Global Head of Research at UniCredit.
Pound To Euro Exchange Rate Muted Following Lackluster German Data
The Pound Euro conversion traded mostly flat on Tuesday following the publication of Germany’s latest Zew economic sentiment index.
GBP/EUR Exchange Rate Flat Following German Economic Sentiment
The Pound Euro (GBP/EUR) exchange rate traded in a narrow range on Tuesday following the publication of Germany’s latest Zew economic sentiment index.
At the time of writing, GBP/EUR was trading at approximately €1.1820, showing no significant change from Tuesday’s opening rate.
Euro (EUR) Subdued Following Data Release
The Euro (EUR) traded mostly sideways against the majority of its peers on Tuesday following the release of Germany’s latest Zew economic sentiment index.
Although the data edged higher for this reading, rising from 47.1 in May to 47.5 in June, the index missed forecasts of a 50.0 print.
Commenting on the release, ZEW President Professor Achim Wambach said: ‘Both the sentiment and the situation indicators stagnate. These developments must be interpreted in the context of a constant situation indicator for the eurozone as a whole. In contrast, the inflation expectations of the respondents increased, which is likely related to the inflation rate in May, which turned out higher than what was expected.’
As such, the Euro struggled to catch bids in the aftermath of the release.
Pound (GBP) Hobbled by Falling Grocery Inflation
The Pound (GBP) was on the back foot against the majority of its peers on Tuesday following the release of the UK’s latest grocery inflation data.
Grocery prices in the UK continued their downward trend in June, with inflation falling to 2.1%, according to market research firm Kantar. This marks the 16th consecutive month of easing inflation.
The group also reported that prices are now falling in almost a third of grocery categories, including butter and milk, and mentioned wet weather as the main driver for June’s reading.
Kantar’s Fraser McKevitt explains: ‘We’re not yet reaching for those typical summertime products and are making some purchases you wouldn’t expect in June. Consumers bought nearly 25% fewer suncare items this month compared with last year, while prepared salads dipped by 11%. On the other hand, warming fresh soup sales jumped by almost 24%.’
Just a day ahead of the UK’s latest consumer price index, Tuesday’s grocery data saw GBP struggle to catch bids.
GBP/EUR Forecast: UK Data in the Spotlight
Looking ahead, the primary catalyst of movement for the Pound Euro exchange rate will be a duo of impactful data from the UK.
On Wednesday, the UK will release its latest CPI data for June. With headline inflation expected to return to the Bank of England’s 2% target, this will likely ramp up BoE interest rate cut bets, and in turn, undermine GBP.
On Thursday, the UK’s central bank will deliver its latest interest rate decision. No policy changes are expected to be delivered during this month’s meeting, and with the UK general election fast approaching, the bank’s forward guidance will likely be limited, which may, in turn, disappoint GBP investors.
Turning to the Euro, Eurozone economic data will be few and far between, which may leave the single currency vulnerable to shifts in market mood. As a safe-haven currency, any move towards upbeat trade could see the Euro falter against its peers.
GBP/EUR Long (Buy)
Enter At: 1.1869
T.P_1: 1.1925
T.P_2: 1.1978
T.P_3: 1.2043
T.P_4: 1.2084
T.P_5: 1.2131
T.P_6: 1.2192
S.L: 1.1736
UK Inflation Target Hit, Sterling Up (Short-Term?) by signalmastermind on TradingView.com
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