Sterling continues to trade on the back foot this morning as the growing flock of doves at the Bank of England gets their second piece of confirmatory data to suggest a rate cut at the end of the month may be a done deal.
This morning’s CPI inflation report undershot expectations across the board to post a 1.3% YoY growth in prices, the slowest rate since November 2016.
The core inflation measure, the more apt gauge given the change in energy prices in the UK in the second half of 2019, also dropped to a three-year low as inflation measures continue to converge to the Bank of England’s Q1 2020 target of 1.25%. It must be noted, however, that the downturn in the inflation data wasn’t as broad-based as the headline data suggest.
While this data point doesn’t necessarily change much for the Monetary Policy Committee as the slowdown in inflation was widely expected, it does jolt markets yet again as the data continues to undershoot economists’ expectations.
Compounding with Monday’s GDP reading, which can be cast to one side due to political factors, this week’s data has set the scene for the more important data releases to come. Retail sales data on Friday will give markets a gauge of how the UK consumer saw out the year after propping up the economy after it was riddled with political uncertainty. Whereas next week’s labour market data and preliminary PMIs for January should shed some new light to the dovish narrative.
For now, sterling continues to trade heavy as fixed income markets begin to price a more than 60% probability of a rate cut by Carney and Co at the end of the month.
With only 75 basis points to work with should the UK economy experience a substantial negative shock, the prospect of a pre-emptive rate cut by the central bank begins to gain further credibility, especially if the data continues to build upon the narrative of a more structural slowdown in the economy.
Markets are quickly adjusting to this being the likely scenario going forward but there is still much to play for with the data calendar next week.
Chart 1: markets are becoming more accustomed to a rate cut by the Bank of England as reflected in both sterling and OIS pricing
Author: Simon Harvey, FX Market Analyst at Monex Europe.