Sterling (GBP) strengthened on Wednesday and rallied against the greenback after the release of hotter-than-expected inflation data for March.
UK inflation data
The Office for National Statistics (ONS) reported that the Consumer Price Index (CPI) rose by 3.2% annually, surpassing economist forecasts, while core CPI, excluding volatile food and energy prices, increased by 4.2%. March’s inflation data signalled a slowdown from February, implying that the Bank of England’s (BoE) decision to raise interest rates has helped alleviate price pressures. The moderation in producer price inflation further suggests that businesses are reducing prices amidst subdued demand expectations.
While slightly elevated inflation levels might cast doubt on expectations for a BoE rate cut in November, recent employment data suggests that the labour market is cooling as employment has declined and the Unemployment Rate surged to 4.2% for the three months ending February.
BoE and Fed monetary policy differentials
In the broader market context, the pound’s recovery amid a firm US dollar reflects the contrasting monetary policy outlooks between the BoE and the Federal Reserve. While the BoE is facing inflationary challenges, Fed Chair Jerome Powell’s hawkish stance on interest rates has boosted the USD. Powell emphasized the need to maintain higher interest rates for an extended period, citing robust labour demand and sluggish progress in achieving the Fed’s 2% inflation target.
Fight against inflation is not over
Inflation is expected to drop further in April, possibly below the bank’s target of 2%, due to lower domestic energy bills. This, in turn, could encourage Bank of England policymakers to start thinking of cutting rates in the next few months. However, several policymakers have warned that the fight against inflation isn’t over yet with price pressures anticipated to increase in the second half of the year.
BoE rate cut expectations diminish
According to Bloomberg, traders trimmed their expectations on the extend of monetary easing by the BoE following the hot inflation data.Traders have now fully priced one quarter-point reduction by November and a 30% chance of a second cut which was later pared. With services inflation remaining high, rate cuts are now forecast to be delayed. The possibility of higher-for-longer rates has boosted the pound. The inflation data may support recent hawkish commentary by MPC members who have stressed that rate cuts in the UK should still be a way off and not come earlier than the US.
Geopolitical tensions have supported the USD
Worries about an escalation of tensions between Iran and Israel have increased and this could impact market volatility. Israel has pledged to retaliate against Iran, while the US expressed its support to Israel and its readiness to impose sanctions on Iran. Geopolitical fears have provided support to the safe-haven dollar.
Looking ahead, investors will be focusing on further developments in geopolitical tensions and central bank commentary for further clues on currency movements. The USD Index is anticipated to continue rising, supported by Powell’s promise to keep higher interest rates following a tight labour market and hot inflation.