Inflation Surprise Drives Pound

Inflation remains at 3%

The rate of inflation in the UK was unchanged in January remaining at 3% despite the recent rise in the pound and November’s rate hike. This justified the slightly more hawkish tone of the comments from the MPC following its meeting last week as it seems higher rates are the only “tool in the box” the Bank has to fight inflation.

The concern will be that any rate hike will see business investment, which is extremely weak due to the uncertainty over what Brexit will do to order books, collapse. There is a fine balance to be struck even in “normal times” between applying sufficient stimulus to allow the economy to grow without pushing wages and prices higher. The possibility of a rate hike in May grew following the release of the data although any fall in the February data will see hawkish sentiment evaporate.

The pound rose against the dollar but stayed in a relatively narrow trading range. It reached 1.3925 before dropping back to close at 1.3886. It has stayed in a tight range overnight remaining close to the 1.3900 level. It fell against a stronger Euro making a low of 1.1223 and closing at .1238.

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Inflation data due in US

Today sees the release of inflation data for January in the United States, Price increases have remained benign even as growth has started to accelerate. The recent employment report showed that wage growth is starting to pick up and this is a normal precursor of higher prices.

Traders are nervous about today’s data following the rise in the dollar mostly attributed to risk aversion as equity markets correct but also due to the likelihood of a series of rate hikes by the Federal Reserve this year. Headline inflation, ex food and energy, is expected to have risen by 1.7% in January down from 1.8% in December and still shy of the 2% target.

Jerome Powell the new Fed. Chair is known to favour a reactive stance to rate hikes so any fall in the rate of price rises is likely to see the next hike deferred. So far, Powell has concentrated on the risks associated with volatility in equity markets and hasn’t yet made any comment on the Fed’s outlook for interest rates.

The dollar index remains in a narrow range following last week’s rally. It reached 89.50 yesterday and has remained close to the same level overnight. Retail sales data will also be released today with an unchanged 0.4% increase expected.

Gradual Euro climb continues

The single currency continues to appreciate gradually versus its G7 counterparts as Eurozone economic data remains supportive. Inflation is a little lower than the ECB’s desired level and today’s inflation report in Germany followed by next week’s regionwide data will confirm that view.

The Euro makes up a little over 57% of the dollar index but the dollar only makes up 13.6% of its Euro equivalent. This reflects the relative trade positions of the two countries and demonstrates why the Chinese currency is the largest constituent part of the “Eurobasket” at 23.3%.

By this measure the single currency has only rallied by marginally less than 7% in the past twelve months rendering its rise against the dollar less significant to Mario Draghi and his reluctance to change monetary policy.

The Euro reached 1.2372 yesterday and has reached 1.2393 overnight. It has drifted back below the resistance at 1.2380 and it is unlikely to push through and hold above that level until after the German inflation data which is expected to show continued strength in the region’s largest economy.

The pound has been steady overnight versus both the dollar and Euro, staying within yesterday’s ranges