BOE's Tighter Monopol Might Be Working

After the surprise monthly increase in UK GDP, the BOE could get more good news. Meanwhile, EU inflation is expected to confirm a dramatic slowdown.

Energy price cap weighs on UK inflation 

Britain's two largest trade partners - the US and the EU - have seen significant slowdowns in inflation in recent months. Most of it has been thanks to falling energy prices. But that phenomenon is not being repeated in the UK, in part, thanks to the price cap that prevented household energy prices from rising in the first place. However, the prices of other goods and services have risen even more. This has left the UK peaking at an inflation rate above that of its main trading partners, but without the benefit from falling energy prices.

Although some benefit is expected from lower fuel costs, higher food prices are expected to offset that. This is why headline and core inflation are forecast to move lower by a small amount, serving as an argument that the tighter monetary policy is working. Markets at the moment see a 65% chance that the BOE will raise rates by 50bps at the next meeting.

Inflation differential most important

The headline inflation rate is forecast to drop to 10.5% compared to 10.7% in November, on an annualised rate. Meanwhile, the BOE-tracked core annualised CPI change is expected to tick down to 6.2% compared to 6.3% prior. Monthly inflation is expected to remain unchanged at 0.4%.

A couple of hours later, we get the final CPI figures for the Euro Zone, which are expected to confirm the preliminary numbers reported earlier. That is expected to show a large drop in the annualised headline rate to 9.2% from 10.1%. But, what's more complicated for the ECB, the core rate is expected to rise to 5.2% from 5.0% prior. The latest survey by Bloomberg shows an expectation for a 50bps hike at the next ECB meeting.

With both central banks expected to raise by the same amount, the focus for the currency pair is likely to turn towards the inflation differential. 

EUR/GBP due to correct

Euro has risen against the pound since December after breaking past two corrective patterns: a pennant leading the pair towards 0.89 and a flag facing rejection. With a pullback at play, prices could consolidate before rising to the measured move leg up at 0.8875 unless the flag gets invalidated and prices slide to 0.8770. Breaking above the ceiling could lead the pair to 0.8940 with stop a or reversal at 0.8875. Inversely, losing the flag floor could open the door to 0.8650 if the 0.8713 support gets breached.

Source: Spreadex

Key takeaways

The UK's inflation rate is higher than its main trading partners, but this is not due to lower energy prices. Core inflation is forecast to move lower by a small amount, which could serve as an argument that the tighter monetary policy is working. With the core inflation rate in the Euro Zone expected to rise to 5.2% and both central banks expected to hike, the focus will likely turn towards the inflation differential.