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Today’s UK CPI figures should have been the catalyst for a rally in the pound against the dollar. Price growth, in both the headline and core numbers, came in ahead of expectations. But the response from GBP/USD was a tremendous shrug of the shoulders. Instead of pushing on to $1.30, the pair lost ground slightly.
Price action, as the saying goes, is the only indicator. It is true that we still have unemployment and wage data release tomorrow, and then retail sales on Thursday, before we have a fuller picture of the state of the UK economy. But the CPI number is the most important figure this week, and on today’s evidence it looks like we could be due a retracement in GBP/USD, if only as part of a wider uptrend.
The broadly uneventful reaction to article 50 notification, and the announcement of a snap general election, caught the market napping. The skies did not fall after the UK notified the European Union (EU) of its intent to leave, and then the election news confirmed (based on current polling), that Theresa May is to remain the UK’s Prime Minister for the next five years. This change in fundamental news caused a reassessment of the pound’s outlook, and a market that was still broadly short was forced to begin changing its view. Short positions were bought back, creating an upward momentum that soon gathered pace, and resulted in GBP/USD recovering some of the ground lost over the previous six months.
Now, all that is ‘in the price.’ The Bank of England (BoE) has already signaled that it will tread carefully where higher interest rates are concerned, even if inflation does run above target. This is in no small part due to concerns that the divorce negotiations with the EU will create significant uncertainty that will feed through to the broader economy, while weakness in wages means that UK consumer spending will remain constrained.
Longer-term, the path for GBP/USD appears higher, especially since the Federal Reserve may struggle to raise rates twice more this year, and this could boost USD weakness. By the end of 2017, $1.30 and higher is still eminently possible, but we could see the pair struggle over the summer, at least until the path of UK inflation becomes clearer.