Pound falls after UK inflation data

OVERNIGHT

Asian equity markets were mixed following the positive end to trading on Wall Street. Mainland China and Hong Kong indices fell on concerns about the economic outlook. Markets elsewhere in the region, however, were mostly firmer. Ahead of the UK inflation release, US Treasury yields were lower, and the dollar was up modestly amid narrow ranges.

THE DAY AHEAD

UK June CPI inflation data released earlier this morning surprised on the downside for the first time in five months. The headline annual rate fell to 7.9% from 8.7% in May, compared with our and the consensus forecast for 8.2%. The core rate of inflation, which excludes energy and food, fell unexpectedly to 6.9% from 7.1%, the first decline since January compared with market expectations for no change. The fall in overall inflation mainly reflected lower petrol prices, while there was also some easing of inflation for food, furniture and household goods, and hotels and restaurants. UK inflation, however, remains well above the levels currently seen in the US or the Eurozone. 

Staying in the UK, there will be attention on Bank of England Deputy Governor Ramsden’s speech later today (5pm) on quantitative tightening (QT), which is the process of unwinding quantitative easing (QE). The Bank has been reducing its balance sheet by not reinvesting maturing bonds and actively selling bonds. Markets will be attuned to any indications on whether the pace of reduction in asset holdings will be stepped up later in the year. 

In the Eurozone, June CPI is due but it is a final reading. It will nevertheless provide additional detail compared with the preliminary ‘flash’ estimate. The flash estimate showed a fall in the bloc’s headline inflation rate to 5.5% from 6.1% in May, driven mostly by lower inflation for energy and food. On the other hand, core inflation, excluding energy and food prices, increased to 5.4% from 5.3%, led by a rebound in services prices. The still-elevated core inflation rates mean the ECB is highly likely to increase interest rates again at next week’s policy update.

In the US, the housing sector is one area that has clearly been hit by higher interest rates but some recent data has suggested that activity may now have started to roll over. It will be interesting to see whether today’s housing starts and building permits data provide any support for that. The data follow yesterday’s retail sales report, which showed broadly resilient consumer demand. 

MARKETS

The pound fell sharply after UK CPI inflation fell more than predicted which will raise speculation the next BoE interest rate rise in two weeks’ time may be smaller than the 50bp increase at the last policy meeting. GBP/USD and GBP/EUR dropped below 1.30 and 1.16, respectively. The UK 10-year gilt yield closed down 10bp to 4.33% yesterday, while US Treasury yields moved lower this morning after the UK data.