BoE preview — will crude and sterling dampen the rise of inflation?

With Super Thursday looming, there is good reason to believe that a reversal for both crude prices and the pound may stifle the ascent of inflation.

Bank of England
Source: Bloomberg

Thursday sees the Bank of England come back into focus, with yet another Super Thursday on the cards. The release of minutes, and the inflation report alongside the usual rate decision means we are likely to see some volatility even if rates and quantitative easing remain steady as is expected.

Of all the elements, it is the inflation report which will likely garner the most attention, given the release of growth and inflation forecasts which will shape the Monetary Policy Committee’s outlook going forward. As we can see below, the economic picture in terms of growth and jobs is relatively encouraging, especially given that as yet we have seen no negative impact to either as a result of the referendum result. 

What we have seen is a significant pickup in inflation, with both core and headline CPI rising sharply over the past 12 months, albeit headline inflation rising at a much faster rate. This is a reflection of a sharp rebound in oil prices, with crude rallying abruptly as a result of the recent output cuts.

However, arguably we are unlikely to see crude gain anywhere near as much in 2017 as we saw in 2016. With the US likely to ramp up production, there is good reason to believe we are just as likely to see prices fall as rise in the coming year. With that in mind, the rate of change in headline CPI should slow down and any reflection of that the BoE’s forecasts would likely be supportive of the pound.

Finally, we have the influence of the pound, which has only recently begun to rebound following a long-lasting period of decline. With the EU representing the main trading partner of the UK, the decline in GBP/EUR represents a highly influential factor for inflation. There is an obvious inverse relationship, with the 2016 devaluation of the pound leading to higher import and input costs. With that in mind, the question is whether we will see further sterling weakness to push up inflation, or else a period of strength to dent the ascent of CPI.

There is no doubt that we are likely to see the economy tested heavily in the coming years, yet for now, we are in a period of relative stability. With Theresa May having laid out a plan which looks a lot like a hard Brexit, the sterling weakness that came with each hard Brexit comment is likely to come to an end. We are also seeing a more positive outlook given the comments emanating from potential partners in the US and Canada. With that in mind, we are likely to see the pound continue to rise, thus dampening the recent rise of inflation. Crucially, unlike oil, this would impact both core and headline inflation.

All in all, we are seeing a potential reversal or slowdown in both the ascent of oil prices and devaluation of the pound. Both of these were major factors that led to the rise of inflation, driving more hawkish sentiment at the BoE. Should we see projections start to reflect these factors, there is a good reason to believe we will start to see a more dovish stance going forward.

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