GBP jumps on unexpected inflation increase

Summary:

• UK inflation accelerated in August well above the levels expected by economists

• A squeeze on companies' profits lowered as input prices continued moving down

• GBP seems to be en route to 1.3340 aided by upbeat Brexit-related remarks

The British pound rose to its two-month high after the release showing that inflation accelerated well above the level expected by economists. This supports the GBP justifying a rate hike delivered by the Bank of England last month. The data may call into question how quickly inflation will be coming back to the target and if this is not just one-off event, it may force the central bank to continue monetary tightening at a time of Brexit-related uncertainty.

UK inflation sped up in August but input prices drove down decreasing a gap to output prices and thereby taking off the squeeze on companies’ profitability. Source: Macrobond, XTB Research

Price growth in the UK economy totalled 2.7% and 2.1% when it comes to headline and core inflation respectively. Both readings turned out to be far above the median estimate of forecasts compiled by Bloomberg as economists generally had anticipated inflation to slow down slightly. The details show that higher prices were caused mainly by the cost of theater shows, computer games, transport fares as well as clothing. As one may notice not only headline categories saw an increase in prices hence we got a decent pick-up in core price growth as well. It is worth noticing that a 3.6% jump in the category of recreation and culture was the highest since 2010. There is no doubt that the data may raise concerns when the bank is able to bring inflation back to the target. It needs to be said that money markets do not see any chances for more rate rises before the UK leaves the European Union in March next year. Basically, the next 25 basis points increase in May looks as a toss-up. In spite of the fact that we have been recently offered encouraging comments regarding Brexit (Theresa May signalled that a deal “is virtually agreed”) there is no doubt that investors will remain sceptic until a binding agreement is reached which may take time. On that account we reckon the ongoing rally in the pound could be built on a weak foundation. On the flip side, we do not question the remarkable undervaluation of the pound and still expect the currency to be one of the major winners among its G10 peers once Brexit-related anxiety subsides altogether. If all things go well, one may imagine that the major obstacle for the GBP could be removed yet this year allowing the currency to experience a more long-standing rally.

Let us make the final point with respect to the inflation report for August which could be UK companies supportive. Namely it is the fact that input prices continued to decline last month showing a decrease to 8.7% from 10.3% in annual terms. Simultaneously, output prices moved down just moderately to 2.9% from 3.1% matching the consensus. This implies that UK companies faced less pressure on their profitability in August and if this trend continues unfolding, it should ultimately help the BoE in lowering price growth back to the goal. Either way, right now we are having inflation above the target irrespective of what a gauge (headline or core) we are focusing on. This could alarm the MPC which ought to stick to its hawkish stance going forward buttressing the pound in the medium-term as well.

Looking at the daily chart of the GBPUSD one may arrive at a conclusion that the pair could continue climbing in the near-term up to 1.3340 where a more notable resistance might be identified. This level is being supported by the 38.2% retracement of the downward swing from April this year. Having said that, we think that a turning point for the pound nears hence one may expect that the balance of risks should be tilted to the upside in the months to come. Source: xStation5