UK CPI Inflation Rises to 40 Year Highs, GBP/USD Under Pressure

Surging Inflation

The United Kingdom is troubled by extremely high inflation and today's data reveled that headline Consumer Price Index (CPI) ticked-up 9.1% in May year-over-year, compared to 9% in the prior month. This is the highest rate in the the National Statistic series, which began in January 1997, while the indicative model series suggests that CPI would last have been higher in around 1982.

What appears to be encouraging though, is that CPI rose by a small amount compared to the previous reading, while Core CPI which excludes energy prices, moderated to +5.9% year-over-year, from 6.2% prior.

In order to rein inflation in, the Bank of England (BoE) was one the first central banks to hike rates and this month it delivered its fifth increase in a row, bringing rates at 1.25% - the highest level since January 2009.

However, it once again did not break from the 25 basis point moves tradition and its conservative strategy does not seem to work, since its sees more pain ahead for consumers. During last week's monetary policy decision, it upgraded its projections, now expecting CPI inflation to rise to slightly above 11% in October. ^[1]

Recession Fears

The BoE may have missed a huge opportunity to front-load its tightening with larger rate increases earlier in the cycle, as fears of an economic slowdown could make future hikes more difficult. The UK economy grew at a solid pace (8.7% y/y) in the first quarter as per last month's preliminary reading, but the central bank expects GDP contraction in the last quarter of the year. ^[2]

Furthermore, recent monthly data have also been discouraging, since GDP shrunk by 0.3% in April (month-over-month), after a 0.1 contraction in March.
Industrial Production also declined in April, by 0.6% month-over-month, while the Unemployment Rate ticked up to 3.8%.

Of course the United Kingdom also has to deal with post-Brexit headwinds, with a study by the Resolution Foundation finding early signs that the EU–UK Trade and Cooperation Agreement (TCA) is reducing openness and the competitiveness of the UK. The report also concluded that headline real wages are expected to be 1.8% lower than they would be, if the UK remained in the EU. ^[3]

BoE-Fed Policy Differential

The Bank of England may have been raising rates since December, way before the Fed's March lift-off, but US officials have already produced 150 basis points worth of hikes. Last week, they hiked by the most in nearly thirty years, reacting to the latest resurgence in CPI Inflation.

Furthermore, they pointed to more tightening ahead and they do not seem overly worried about the contraction of the US economy in the first quarter, while the BoE seem to be more concerned about a possible recession.

More to it, the Fed talked of "unconditional" commitment to restoring price stability, in last week's report to the US Congress, ahead of today's and Wednesday's testimony of Chair Powell. ^[4]

GBP/USD Analysis

The policy differential is still unfavorable for the pair, given the more aggressive action and pronounced resolution to fighting inflation by the Fed, while we need to not forget the political landscape. Prime Minister Johnson may have survived the recent no-confidence vote against him, but his political future is far from secure and political uncertainty could resurface down the road.

GBP/USD did not have a big reaction to today's CPI data, perhaps as markets are cautious ahead of Mr Powell's Congress testimony, which could determine the next leg.

The downward bias remains intact and the pair is vulnerable to 1.2069, but further decline towards and beyond 1.1904 would need fresh catalyst.

On the other hand, GBP/USD managed to stage a recovery after last week's 2+ year lows and the new one started in a good mood. This gives it the right to make another push towards the EMA200 (1,2440-50), but it does not inspire confidence for sustained recovery at this stage. The technical landscape is also tough, since the daily Ichimoku Cloud and last month's high loom large.