What 3-decade High UK CPI Means for GBP

The latest UK CPI data came in above expectations and near a 3-decade high, keeping the door open for a BoE interest rate hike soon.

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Initial reaction

The pound got a bounce on the headline CPI after it showed that inflation in the UK beat expectations at a rate of 4.8% y/y. According to the ONS, this is the highest figure since 1992 - a 30-year high. But the move wasn't as dramatic and faded in the minutes after the release.

It seems that the market was already pricing in record-high inflation so a beat of expectations by a decimal or two doesn't change the outlook too much. 

Meanwhile, some of the "faster" indicators showed that inflation might be moderating. That could be a contributing factor to why the market didn't have such a strong reaction.

It's about the timing

At the same time as the headline CPI data, we also got Producer Price Index data. That came in below expectations. Monthly non-seasonally-adjusted PPI input came in at -0.2% compared to 0.6% expected. This could lead many analysts to conclude that inflation starting at the factory gate, which then translates to consumers, might have peaked. If the BoE has a similar thought process, it could wait longer to raise rates.

One of the persistent themes for forex traders is a lack of trust in the BoE's messaging since, for a while, Governor Bailey has been saying that a rate hike was coming. But for months, nothing happened. And before Bailey we had Mark Carney, who came to be known as the “unreliable boyfriend”. It has gotten to the point that the market was surprised at the rate hike at the last meeting, and would probably be surprised again were another hike to come in Feb.

Policy matters more than politics

On the political front, conservative backbenchers said yesterday that they expected to get enough letters for the 1922 committee to push for a no-confidence vote against PM Johnson. However, as we noted in our report last week, the markets seem to view this as immaterial to the currency outlook. It's likely to continue to be all down to how the bond yields respond to expectations around monetary policy.

The yield game

The latest pricing shows a widening gap in government bond yields between the UK and the EU. While German bund yields did move higher in sync with US Treasuries, the real yield across the Channel widened due to the differential in EU/UK inflation. 

What does the CPI print mean for EUR/GBP?

The euro-pound currency cross remains inside a long-term sideways range. Newfound BOE hawkishness means the price is sitting just above major support at 0.83.

High inflation and expectations for another BOE rate hike are reasons to expect a breakdown from 0.83. However, if inflation expectations are moderating and the BOE turns more cautious then 0.83 could hold.

EUR/GBP Weekly candlestick chart

Source: SpreadEx trading platform

Key takeaways

CPI data today has something for the bulls and the bears. As such, traders might opt to wait until February 3rd to get a clearer picture of BoE's policy stance at the MPC meeting. Only then will Bailey provide hints about the path to "normalisation." Despite much being priced in, the path to BoE's hawkish cycle hangs on Baily's words.