UK Inflation Back at 2% but Services Inflation Remains a Concern, GBP/USD Rises

UK Inflation Rate:

• UK Inflation Rate YoY reaches 2% yet services inflation poses a challenge.
• UK Core Inflation Rate YoY 3.5% down from a previous print of 3.9%.
• GBP/USD rises as 1.2750 resistance area beckons.

The Bank of England (BoE) will likely have mixed feelings this morning following the release of the May inflation report. Inflation has hit the Central Bank’s 2% target for the first time in nearly 3 years but the gap between goods and services inflation is a concern. 

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As always though one has to look at the entire picture and delve deeper into the data. Underlying price pressures in the service sector remains a particular sticking point coming in at 5.7%. The BoE believes that this figure gives a better picture of the medium term inflation risks and could be the reason we are seeing a rise in the GBP this morning as well as mixed reactions regarding the timing of a first rate cut from the BoE.

If we take a look at the different sectors, the drop in inflation was led by a slowdown in food, with prices falling this year but rising a year ago; the largest upward contribution came from motor fuels, with prices rising slightly this year but falling a year ago. Core CPI (excluding energy, food, alcohol and tobacco) rose by 3.5% in the 12 months to May 2024, down from 3.9% in April. The CPI goods annual rate fell from negative 0.8% to negative 1.3%, while the CPI services annual rate eased from 5.9% to 5.7%.

Bank of England Conundrum

The Bank of England (BoE) is well aware that the fight against inflation is far from over. The data released today is unlikely to result in a rate cut at tomorrow’s BoE monetary policy committee meeting. The BoE has in the past stated a return of inflation to its target is not enough on its own for rate cuts to begin. The uncomfortably high services inflation prints continues to be the major stumbling block as the gap between services and goods inflation is the widest on record all the way back to 1990. 

Interest Rate Probabilities for the Bank of England (BoE)

Source: LSEG Eikon (click to enlarge)

The likelihood of a rate cut tomorrow is 5.9%, while a rate cut in August is not guaranteed, currently standing at 31.2%. September appears the most probable for a rate adjustment at this stage. Since Covid-19, central banks have struggled with accurate predictions due to conflicting data releases. This uncertainty leaves market participants puzzled, so I would advise against making bold predictions and suggest instead basing assessments on upcoming data releases.

Market Reaction

The immediate reaction to the data release has been a positive one for the GBP. Cable pushed away from the 1.2700 handle rising to a high of 1.2732 before taking a pause as market participants eye the potential for further gains with the US bank holiday today. Looking at the H4 chart below and immediate resistance rests at the 1.2750 handle with a break beyond that opening up a retest of the 1.2800 or the most recent highs around 1.2850.

Alternatively, a rejection at resistance or a push lower from current price will see cable needing to navigate its way below the 1.2680 support area before eyeing the recent lows at 1.2650. A break of these lows could open cable up to a much deeper retracement with the next significant support area around the 1.2560 handle.

GBP/USD Daily Chart, June 19, 2024

Source: Tradingview.com (click to enlarge)

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