UK inflation reaches highest level since Nov 2014

Market headlines are continuing to focus on the UK economy after data earlier today showed that inflation accelerated in July with CPI rising to an annualised 0.6%.

This week represents the first true week of economic data from the United Kingdom following the unexpected Brexit outcome of the EU referendum vote, but a few shocks are already being heard after the news that import prices increased at the strongest rate since 2011. The news that import prices have increased by such a staggering amount shows that the collapse in Sterling is already having an impact on imports and should feed through and lift inflationary pressures over the upcoming months.

There is now an emergence of expectations that headline inflation could overshoot the Bank of England’s (BoE) 2% target over the coming quarters, which would provide a dilemma for the BoE as the central bank is being forced into an easing bias as the UK growth outlook weakens. Usually when there is a risk that inflation could exceed a central bank target, the respective central bank would find themselves under pressure to ease pressure by lifting interest rates higher, however this not an option for the BoE who are having to ease policy in the aftermath of the EU referendum outcome.

While the GBPUSD has moved higher throughout trading on Tuesday, this is more likely to be a short correction following a recent period of significant losses. The gains in the GBPUSD are likely to find themselves capped somewhere between 1.3020-50 at this point in time, while the risks for the pair remain skewed to the downside  for the future, as the UK economic outlook continues to deteriorate. Sterling was unable to benefit from substantial weakness in the Dollar since the end of last week, which points out that the overall buying sentiment towards the British Pound remains very weak.

Dollar slump aiding EURUSD

Dollar weakness, following a heavily disappointing US retail sales release and another resumption of crumbling US interest rate expectations, has resulted in the Dollar drifting sharply lower against the majority of its trading partners. The crumbling of the USD has catapulted the Eurodollar to its highest level since late June at 1.1275. As US interest rates continue to be pushed back the Eurodollar can continue to drive higher, although any move between 1.1300 and 1.1320 could expose an over-extension and trigger the alert of sellers.

Expectations over the US Federal Reserve being able to raise US interest rates in 2016 seem to be being pushed back by the minute, while investors will be awaiting  further clues around the intentions of the Federal Reserve in 2016 when the US central bank releases its latest meeting minutes tomorrow. Although the Federal Reserve is trying to maintain a public stance towards raising US interest rates, you just have to monitor the ongoing resumption of crumbling rate expectations to gain an understanding that investors are not confident at all that the Federal Reserve will realistically carry through with the pledge to raise interest rates.

Japanese Yen remains trader’s choice

The Bank of Japan (BoJ) is likely to wake up to concerns on Wednesday morning after the USDJPY fell below the highly psychological 100 level just moments ago. There is a lot of speculation that the BoJ are ready to intervene in the markets as the USDJPY approaches 100, but the real concern for the central bank must be that traders are constantly attracted towards the Yen despite everyone knowing that a strong Yen is the complete opposite to what the BoJ desires. The correlation between such consistent buying demand for the Yen and equity markets is very unusual and in fact, the relationship should be moving in the opposite direction.

Such consistent buying demand for the Yen just shows that investors are still attracted towards the currency as a safe-haven in light of the uncertain external environment that is weighing on global growth prospects. This is also going to be a problem for the BoJ if the central bank does press the panic button on aggressive stimulus in an attempt to weaken the Yen, because traders could reject the stimulus and continue backing the currency as a safety asset.

Ahmad is vice president of market research at FXTM