Pound higher after UK inflation surprise

OVERNIGHT

US equity markets ended lower and their Asian counterparts are trading in the red as investors continue to assess US default risks, and its economic and market ramifications, in the absence of a political agreement on raising the debt ceiling. According to reports, progress in negotiations was limited and no further meetings have been planned. Elsewhere, New Zealand's central bank raised interest rates by 25bp to 5.5% as expected, but the surprise was the signal that rates may have peaked.

THE DAY AHEAD

UK inflation figures, released earlier this morning, revealed a fall in headline CPI to 8.7% in April, down from 10.1% in March. However, the drop in the annual rate was smaller than expected compared to consensus forecasts of an 8.2% outturn and even our own forecast for 8.4%. The decline was driven by energy price base effects due to the sharp increase in household bills in April 2022. More declines in headline CPI are likely in the coming months, with Ofgem due to announce a fall in its energy price cap for July on Thursday. Policymakers, however, remain concerned about risks of second-round effects on domestic prices and wages and ‘stickier’ services inflation. Core inflation (excluding food and energy) in April rose to 6.8% compared with 6.2% in March.

Ahead today, the CBI industrial trends survey will provide an update on UK manufacturing sentiment for the middle of Q2. Internationally, the German IFO business survey, also for May, is the key focus. We expect the headline IFO index to edge down to 93.0, snapping six straight monthly increases. Despite that, the ECB remains focused on getting inflation down and is on track to increase interest rates again next month.

The minutes of the Fed’s May meeting, during which the fed funds target rate was increased by 25bp to a 5.00-5.25% range, will be released this evening. The Fed is expected to ‘pause’ in June, but positive data surprises and hawkish rhetoric from rate-setters could change expectations. US Treasury yields have risen in recent sessions and markets currently attach about a 20-25% probability to a June rate rise.

MARKETS

The US dollar remains supported, ironically, by the debt ceiling impasse which has weighed on general risk sentiment. GBP/USD fell below 1.24 yesterday but found support this morning after the strong UK inflation data, raising market expectations of another BoE hike next month.