14 Feb 2019: Inflation data keeps Sterling on the backfoot

14 Feb 2019: Inflation data keeps Sterling on the backfoot

Inflation data keeps Sterling on the backfoot

February 14th: Highlights

  • Producer and Consumer prices lower than market expectation
  • Higher U.S. inflation places focus on FOMC
  • Euro testing lows as market backs away

A slowing economy and lower inflation hit the pound

As the Prime Minister continues to work towards changes to the Northern Irish backstop agreement, it is the economy that is driving Sterling.

GDP growth, released earlier in the week, was weaker than expected and there was a surprise fall in inflation to 1.8% year on year in January from 2.1% in December. The main contributors to lower prices were continued weakness in fuel and energy. Despite inflation being below the Government’s 2% target, the Bank of England will remain cautious as the next three months will be critical for the economy as Brexit comes to a conclusion.

Should there be no deal, analysts believe that the pound could fall by between 5% and 10%. This would have an immediate effect on producer prices and would mean an increase in consumer prices “down the road”. The reaction to a deal being agreed would see a rally for the pound but it is doubtful that it would be as large or violent as no deal, as the economy would still struggle in the short/medium term following any type of Brexit.

The pound remained under pressure yesterday following the release of the data. It fell to a low of 1.2843 versus the dollar and closed just a few pips higher at 1.2854. In the short term, there appears to be buying interest around the 1.2840/50 level which is providing support. However, if the Prime Minister is rebuffed in her attempts to get Brussels to change its mind over reopening negotiations, that support will crumble and the pound could fall, initially to test the 1.2720 level.

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U.S. inflation data surprises traders

The dollar resumed its rally yesterday, following a bout of profit-taking on Tuesday, as inflation data showed that ex-food and energy prices rose by 2.2% in January, the same as in December despite expectations for a fall.

The guidance given by FOMC members and the tone of their remarks had led the market to expect a fall in inflation to be one of the more significant reasons that the Fed has paused in its rate hike cycle.

The fact of higher inflation outweighed the possibility that the pause was caused by pressure from the President in providing a boost to the dollar. The greenback retraced all its losses from the day before, reaching a high of 97.19 and closing at that level. It has fallen a marginally overnight as risk appetite has improved a little in Asia.

Retail sales and producer price data are released today in the U.S. Retail sales are expected to have risen marginally while producer prices are likely to be flat given the recent rally in the dollar which will contribute to inflation being well controlled in the short to medium term.

The announcement of the second summit between President Trump and Kim Jong-un is expected soon with Vietnam slated to host. Unless there is a major breakthrough this is unlikely to have much effect on the dollar, given the fact that the first session proved to be disappointing.

Euro finding support hard to find

The single currency is finding it hard to make any headway versus a dollar which continues to find support and the market’s perception that there is no real reason to buy the currency given the economic woes besetting the Eurozone.

Economic data points to a continued slowdown. Despite the ECB continually commenting that it sees individual countries data as of little more than academic interest, today’s release of GDP data from Germany is sure to attract interest. The German economy is expected to have grown at just 0.1% in the period between October and January, contributing to a year on year figure of 0.7%.

As the slowdown in the region continues, it is likely that the German economy will have contracted in the current quarter.

The data will heap more pressure on an already weak currency. The euro fell to a low of 1.1264 yesterday and closed just two pips higher. This was its lowest closing level since mid-November.

With little respite from the well-known pressures that the region is facing, traders are seeing the euro as an almost terminal case and it will need some serious support from the ECB to turn it around. Despite Brexit being considered an almost uniquely Brtish issue, there is little doubt that the Euro will experience a further contribution to the slowdown in the short term but the fallout from a no deal Brexit, while serious, is likely to be short-lived.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”