UK Inflation and Spring Statement Showdown

UK inflation is expected to turn around, but the British economy is still facing challenges which create a dangerous situation for the government's finances and could potentially pressure cable.

A Busy Week for Sterling Traders

UK policymakers are facing a difficult period, but on Monday, they received some positive news that is hoped to be an indication of better things to come. Preliminary PMIs reached a six-month high, well above expectations, suggesting improved sentiment within the private sector. However, there is a nuance: the manufacturing sector fell further into contraction while the services sector expanded. This might complicate the situation for the BOE, as a strong services sector has kept inflation high. On the other hand, private sector employment decreased, which could help alleviate some of the tightness in the market, a factor that has also been a thorn in the side of the central bank.

This comes in the lead-up to perhaps the most anticipated macroeconomic event in the UK, which is the release of the Spring Statement on Wednesday. While inflation is also important, traders are eager to see what Chancellor Rachel Reeves will do with the UK's tight finances, especially after the £20 billion shortfall was discovered and Prime Minister Keir Starmer pushed to increase defence spending. Following the economic pain caused by tax hikes announced last year and the Chancellor's promise not to raise taxes again, raising revenue has become difficult. If she were to be overruled by the Cabinet and Starmer were to push for tax increases, it would reignite rumours of a Cabinet reshuffle that have been circulating since the start of the year.

Prices Go Up, but What About the Economy?

Inflation in the UK is expected to come down to 2.9% in February from a recent multi-month high of 3% for the headline figure. The core rate is also projected to decline slightly to 3.6% from 3.7% previously. However, this is unlikely to convince anyone that this marks a new trend after the January data entirely erased the decline seen in December. Some analysts are not even convinced it will go down, such as Deutsche Bank, which expects further upside to inflation, saying that it will not peak until the March data (released in April).

Attention then shifts to Friday, when February UK retail sales are published. January saw a surprise increase, much to the relief of the government, which expected a continued deterioration of the retail market following the impact of the tax hikes from last year. However, the consensus among analysts is that it was a one-off event, with estimates for UK retail sales showing a drop to 0.3% in February from 1.7% in January. Despite the BOE keeping rates steady by a near-unanimous vote, the pound has struggled to make additional headway against the dollar, with cable largely unchanged over the last couple of weeks. A shift in the data trends over the next few days might help unlock that sideways trend.

Cable's Double Top Dilemma: Pennant or Triangle?

Following the formation of a double top shy above 1.3000, cable is potentially forming a pennant or a triangle pattern. In the former case, losing 1.2888 will expose the pound to 1.2861 and eventually might open the door to the measured move low of 1.2780. However, if the trendline or support holds, a triangle could form instead, paving the way to new highs via the short-term resistance levels of 1.2944 and 1.2975.

Source: SpreadEx / GBPUSD

Key Takeaways

The UK economy faces a delicate situation of rising inflation and faltering growth, which complicates both government and BOE policy decisions. Although inflation numbers are coming up tomorrow, traders will want to focus on the Spring Statement for its impact on taxes and spending. Meanwhile, the latest data releases could provide clues on the trajectory of inflation and consumer sentiment, which may influence BOE actions and impact the pound.