UK CPI Ahead of Likely BOE Hold

The markets expect that the BOE will not cut interest rates at this meeting but instead lay the groundwork for the next, despite forecasted improvements to inflation.

Target in Sight

The markets are facing an intricate situation with cable in the coming days due to key inflation data being released from the UK ahead of the BOE's next policy announcement. Annual CPI is expected to fall slightly below the 2% target to 1.9%, down from 2.3%. However, core inflation is forecast to remain high at 3.4%, though lower than 3.5%. This could convince enough MPC members that inflation is trending in the desired direction, making a rate cut appropriate. Nonetheless, with a general election soon approaching, there will likely be no policy change yet but a signal of scaling back from historically high interest rates.

The UK economy is experiencing a modest recovery following the technical recession of the latter half of last year. Economists generally agree that growth could be faster were it not for the restrictive interest rates to reduce inflation. As such, the Bank could begin easing even if core inflation, which removes volatile food and energy costs, remains well above target. Provided inflationary pressures move in the right way, BOE can take a less restrictive stance. A rate cut would still leave interest rates in tightening territory, though economists differ on exactly where the neutral rate lies.

The Policy Vote

The market will look to understand the BOE's intentions around interest rates. Economists now agree that the first reduction will occur in August, with another 0.25-point decrease later in the year. One indicator will be the vote count compared to last time, when it was two in favor of remaining unchanged against seven votes. Additional members voting to cut rates will be seen as increasing the likelihood of easing policy and could weigh on the pound.

Sterling had experienced some buoyancy against the dollar in recent weeks, helped in part by the dollar's weakness. However, this upside had already been reversed earlier this week, and a stronger signal that reductions are imminent could still push the pair lower. In contrast, an unchanged vote count may leave the market with the impression that policy will remain tighter than expected, potentially lifting the pound higher.

Cable Slows down

The British pound has fallen to a 1-month low of 1.2658 against the dollar just before the two upcoming events. While the overall trend remains upwards, breaking below the lower channel indicates a slowdown unless it offers a reversal instead. A break below 1.2634 could open the door to 1.25 but is unlikely to go as low as 1.2445. Conversely, reclaiming 1.2738 could see prices accelerate to 1.28 to form a head and shoulders pattern, to 1.2861 in a double top scenario, or past it towards 1.29.

Source: SpreadEx / GBPUSD

Key Takeaways

The markets expect that the BOE will not cut rates at this meeting but signal one for the next, despite forecasted improvements to inflation. Annual inflation figures are expected to show a slight decline, though core inflation remains high. The BOE may begin easing even if core inflation remains above target if inflationary pressures trend in the right direction. While economists agree rate cuts are likely in the coming months, the key will be the policy vote count at this meeting, with more votes in favor of a cut signaling a higher probability of near-term easing and potentially weighing on the pound.