UK Core Inflation is Sticky
Yesterday saw a higher-than-expected average earnings index (3m/y) out of the UK at 5.9% (vs 5.1%-forecast). Today inflation has proved persistent with headline CPI (y/y) at 10.1% (vs 9.8%-forecast) and core CPI (y/y) at 6.2% (vs 6.0%-forecast). This suggests at least another 25bps hike from the BoE in May.
It seems the BoE does have a tough job ahead unless the hikes to date start having an effect. Core inflation is sticky and moving laterally (green rectangle). The issue is that it is not showing signs of deceleration i.e., core CPI's ROC needs to move below zero (blue arrow) so that there is a disinflationary process towards target.
2-Year Spread and GBPUSD
The top chart shows the spread between UK and US 2-year notes. Since the end of march, the spread has been moving sideways which suggests that the BoE and Fed policy are seen as similar by the market. However, the stickiness of UK core inflation may tilt the spread in favour of the UK 2-year note. I.e., the BoE may be forced to become more hawkish than the Fed. In this scenario we will likely see the spread take out its overhead resistance.
The middle chart shows GBPUSD and below it is the correlation coefficient between the 2-year spread and cable, which is a robust 63%. This suggests that a tilt in favour of the UK note will favour GBP over USD. In this scenario, in addition to the spread looking to overcome its overhead resistance, GBPUSD will also mount its own resistance challenge.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.