Head of FX Strategy
UK’s inflation is trending lower and that is likely giving some comfort to the Bank of England policymakers. Consensus expects May inflation print, due on 19 June, to ease to 2.0% YoY from 2.3% YoY in April, and the Bank of England itself expects 1.9% YoY.
However, despite headline inflation being on a path to be back below the 2% target, there will be lingering concerns especially on the path of services inflation.
April’s inflation at 2.3% YoY was still above the MPC’s forecast by 0.2% pts, and much of the softening in inflation from March’s 3.2% YoY was energy-driven. More importantly, services inflation has remained a key driver of MPC decisions, and the April print of 5.9% YoY remained 0.4% pts above the MPC expectation.
There also remain concerns about inflation jumping higher again in H2, and BOE’s own forecast has pencilled in an average inflation of 2.4% in H2.
In summary, May inflation report is likely to show headline inflation returning to target and further disinflation progress in services inflation. However, policymakers will need more confidence in the path of inflation before cutting rates. In terms of market pricing, that can mean that a softer inflation print can increase the probability of an August rate cut, which is priced in at less than 50% for now. This could be bearish for GBP in the near-term, but watch for the support at 5-day moving average around 1.2614 especially with the BOE meeting coming up the next day.
The Bank of England policy decision is due on June 20 and the Bank Rate is likely to remain unchanged at 5.25%. Focus will be on the vote split again, which is also likely to stay unchanged at 7-2 with Deputy Governor Ramsden, and external member Dhingra, again set to vote in favour of an immediate 25bps cut.
Markets will also scrutinize comments from Governor Bailey and the MPC regarding the timing of the potential rate cut now that inflation is moving in the right direction, the economy has stagnated in April and the job market continues to ease. An explicit dovish pivot may be premature at this point, however, given:
Like with the US CPI and Fed announcement due on the same day last week, GBP traders will be alert to both CPI and BOE risks this week. While CPI can bring short-term downside especially if services inflation eases from April’s 5.9%, the report is unlikely to shift the BOE’s stance to dovish.
This could mean GBPUSD likely remains trapped in a range between 1.26-1.29. Upside push could come from the election-driven downside for the EUR in the near-term, or even the positive equity risk sentiment. Carry demand is also likely to continue in the low vol summer months, and the post-election uncertainty is likely to weigh on EM FX such as MXN and ZAR suggesting a shift in carry to quality G10 such as GBP.
However, resurgent USD strength and a repricing of the BOE expectations in H2 could mean the GBP upside remains capped, and a bearish scenario could have more legs in H2. Moreover, UK election risks to sterling also appear to be under-priced. The CFTC positioning dashboard also shows a net long positioning in sterling. GBPUSD could, therefore, remain a sell on rallies above 1.28.
EURGBP has broken below key support at 0.85, and EUR faces downside risks for now as we approach the French elections at the end of the month. However, as European election uncertainty diminishes into H2, EURGBP could have room to reverse back above 0.85.
Recent FX articles and podcasts:
30 May: JPY: Intervention fears clash with carry trade attractiveness
29 May: AUD: Hot inflation reaffirms rate cuts remain some way off
Recent Macro articles and podcasts:
10 Jun: Macro Podcast: Nonfarm payroll shatters expectations - how will the Fed react?
Weekly FX Chartbooks:
3 Jun: Weekly FX Chartbook: ECB and Bank of Canada likely to cut rates
27 May: Weekly FX Chartbook: Fresh USD upside from hawkish bolts and trade threats
FX 101 Series:
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