UK Inflation Rise to Pressure Bank of England

Brexit depreciated pound increasing cost of living for Britons

The pound is trading near 10 month highs after the UK government led by Prime Minister Theresa May acknowledged the financial obligations to the European Union after Britain is allowed to exit. The message was seen as a less combative tone than was seen earlier which could actually produce a better outcome as the probabilities of a trade agreement rose. The Brexit referendum vote had a surprise outcome with uncertainty putting downward pressure on the pound as imported goods become more expensive overnight and inflation shot up.

The drop in the pound has hit British households as the pace of inflation has outgunned wage growth, leaving real wage growth in negative territory for 2017. The Office for National Statistics will publish the British consumer price index (CPI) on Tuesday, July 18 at 4:30 am EDT. Inflation was 2.9 percent last month and analysts are forecasting a repeat of that print, but there is risk it could end up at 3 percent.

The Bank of England (BoE) has been divided on how the central bank should deal with current economic conditions. BoE Governor Mark Carney and Deputy Governor Ben Broadbent have been vocal about keeping rates at current levels despite rising inflation. Hawks lost an important member when Kristin Forbes left the rate setting committee in June with a final 5 to 3 vote to keep rates unchanged. Chief Economic Andy Haldane is on the rate hiking camp but will have to recruit more votes to his side and if inflation persists at current high levels that could happen sooner rather than later.

The GBP/USD lost 0.344 in the last 24 hours. Cable is trading at 1.3055 ahead of the release of the British consumer price index. BoE doves have thrown cold water to the idea of a rate hike even as inflation continues to heat up, but the pound has gotten support from a softer more conciliatory approach to Brexit from PM May. Acknowledging there will be a bill to settle after the UK leaves the EU could result in a more amicable divorce reducing the probabilities of the worst case scenario outcomes.

Investor surveys point to a 81 percent expectation of a rate hike within 12 months with the market pricing in around 50 percent in the next six months.

Brexit negotiations kicked off in Brussels as the UK Secretary of State in charge of steering Britain out of the European Union pledged to get down to work. The pound has lost ground ever since the outcome of the referendum was announced and the full economic reality of leaving the EU has not been totally priced in as March 2019 is a more concrete deadline. After securing a majority the cabinet of David Cameron followed through on a campaign promise and put forth the decision to remain or exit at the hands to the people. The outcome of that decision not only terminated his political career, but has put in jeopardy his successor as Theresa May misjudged the electorate when seeking to build on that majority only to see it reduced by calling a snap election. The results leave a less than unified front when negotiations kicked off in Brussels with various rumours of infighting in the cabinet and the fate of the British economy in the air.

West Texas Intermediate graph

The price of oil lost 1.091 percent on Monday. West Texas Intermediate is trading at $46.15 and Brent at $48.36 after the Energy Information Administration (EIA) published a forecast that the total shale regions oil output in August would rise by 113,000 barrels per day. Total output in the month could reach 5.59 million barrels per day compared with 5.5 in June. Oil prices retreated at the start of the week after gaining more than 5 percent last week.

Energy prices have been dictated by weekly changes in US crude inventories and reports from the Organization of the Petroleum Exporting Countries (OPEC) led production cut agreement. Oil rigs have increased production in the United States taking advantage of the stability provided by the production cut deal. Demand specially in China is giving optimistic signals to producers and could be the tie breaker between the two opposing forces. Oil producers that are part of the agreement will meet in Russia on July 24 to discuss the current market situation and review the compliance levels.

Market events to watch this week:

Tuesday, July 18
4:30 am GBP CPI y/y
Wednesday, July 19
8:30 am USD Building Permits
10:30 am USD Crude Oil Inventories
9:30 pm AUD Employment Change
Tentative JPY Monetary Policy Statement
Thursday, July 20
Tentative JPY BOJ Outlook Report
Tentative JPY BOJ Policy Rate
2:30 am JPY BOJ Press Conference
4:30 am GBP Retail Sales m/m
7:45 am EUR Minimum Bid Rate
8:30 am EUR ECB Press Conference
8:30 am USD Unemployment Claims
Friday, July 21
8:30 am CAD CPI m/m
8:30 am CAD Core Retail Sales m/m

*All times EDT
For a complete list of scheduled events in the forex market visit the MarketPulse Economic Calendar

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza