Impact of UK Inflation Report on Pound Sterling and BoE's Policy Outlook | Insights
The Office for National Statistics will release the UK inflation report on Wednesday, and it's expected to have a significant influence on the Bank of England's (BoE) path forward on interest rates and, consequently, impact the Pound Sterling valuations.
A Pivotal Moment for the UK Economy
The United Kingdom's Office for National Statistics (ONS) is set to unveil the high-impact Consumer Price Index (CPI) data this Wednesday. This British inflation report is not just another data release; it's a pivotal moment that could shape the economic landscape in the UK and beyond.
The BoE's Potential Dovish Turn
After the BoE delivered a 25 basis points (bps) rate increase recently, there's a growing expectation that it may follow the European Central Bank (ECB) and signal no more rate hikes this year. Markets are currently pricing in a 75% chance of such a hike. This shift is primarily driven by mounting stagflation risks and cooling labor market conditions that could prompt the BoE to convey a dovish message.
Employment Challenges and Wage Growth
The United Kingdom's ILO Unemployment Rate has been on the rise, climbing to 4.3% in the quarter through July from the 4.2% seen during the three months to June. July also saw the UK economy losing 207,000 jobs, following a shedding of 66,000 jobs in June. Interestingly, Average Earnings excluding bonuses rose by a staggering 7.8% YoY in July, which, although expected, is at a joint-record pace.
The August UK Inflation Report: Key Expectations
The headline annual UK Consumer Price Index is expected to rise to 7.1% in August, compared to the 6.8% growth reported in July. The Core CPI is also anticipated to rise by 6.8% YoY in August, slightly down from July's 6.9% increase. On a monthly basis, Britain's CPI is projected to rebound to 0.7% in the eighth month of the year, after a 0.4% decline in July.
Contributing Factors: Oil Prices and Alcohol Tax
The surge in oil prices and an increase in the alcohol tax are likely to contribute to this renewed uptick in headline inflation. BoE Deputy Governor appointee, Sarah Breeden, agrees with the Monetary Policy Committee (MPC) that the risks to inflation in August are skewed to the upside.
Market Expectations and Probabilities
Analysts at BBH note that the market expects an acceleration in the headline inflation rate, which would be the first since February and would move it further above the 2% target. World Interest Rate Probability (WIRP), a gauge by Bloomberg, suggests odds of a 25 bp hike are around 85%. While a 50 bp hike was largely priced in over the summer, odds of a second 25 bp hike are around 15% for November 2, with expectations rising to top out near 55% for February 1. However, the first cut is still not priced in until H2 2024.
Release Date and Impact on GBP/USD
The UK CPI data will be published at 06:00 GMT on Wednesday. As we approach this crucial inflation data release, the Pound Sterling (GBP) is struggling around a three-month low of 1.2379 against the US Dollar. Expectations of a US Federal Reserve (Fed) rate hike pause this week are helping GBP/USD find some stability.
Potential Scenarios for GBP/USD
A hotter-than-expected headline and core inflation data could reinforce expectations of one more BoE rate hike by the year-end, providing extra momentum to the ongoing recovery in the Pound Sterling. In such a scenario, GBP/USD could build onto its rebound toward 1.2500. Conversely, should the core figure come in softer than the market consensus, GBP/USD is likely to see a fresh downswing toward the critical support level of 1.2308.
Technical Analysis and Key Levels
Taking a look at technical indicators, the 14-day Relative Strength Index (RSI) is listless just above the oversold territory, while GBP/USD continues to extend its consolidative mode just below the 200-day Simple Moving Average (DMA). These technical indicators suggest that the downside potential remains intact in the pair.
Key Levels for GBP/USD
To initiate a meaningful recovery from five-month lows, the major needs acceptance above the 200 DMA at 1.2433.
The next powerful resistance for the Pound Sterling is seen at the 1.2500 level.
On the downside, sellers could target 1.2350 if the recent range is broken to the downside.
Further south, GBP/USD will challenge the May low of 1.2308.
In conclusion, the release of the UK inflation report is a pivotal moment in the economic landscape. It could significantly influence the Bank of England's policy decisions and, consequently, the valuation of the Pound Sterling. Traders and investors should keep a close eye on the data release and be prepared for potential market volatility.
What is the significance of the UK inflation report? The UK inflation report is crucial as it can impact the Bank of England's policy decisions and the value of the Pound Sterling.
Why is the BoE expected to convey a dovish message? The BoE may turn dovish due to mounting stagflation risks and cooling labor market conditions.
What are the contributing factors to rising UK inflation? Factors contributing to rising UK inflation include increased oil prices and higher alcohol taxes.
How might GBP/USD react to the UK inflation data? GBP/USD could either rebound or see a fresh downswing depending on whether the data exceeds or falls short of market expectations.
What are the key technical levels for GBP/USD traders to watch? Key levels for GBP/USD traders to monitor include the 200 DMA at 1.2433, the resistance at 1.2500, the support at 1.2350, and the critical level at 1.2308.
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