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The UK — inflation data surprises to the downside

  • The rate of inflation in UK prices was less than forecast despite the pressures of full employment, rising wages and a devaluing currency.
  • Equity and forex markets take the news in their stride, but Brexit uncertainty still looms over the UK economy.
  • Governor of Bank of England, Mark Carney will take the news as a positive as it offers him more flexibility in terms of policy options.

UK inflation data released Wednesday revealed prices rose less than expected in August despite a range of factors that would have been pushing in the other direction. The drop in the annual rate of inflation from one month to another was the biggest since 2014. The largest downward contributions to the change in the ‘month rate’ between July and August 2019 came from a range of recreational goods and services. These included lower energy prices due to a fall in the price of oil and government price caps on domestic tariffs. The household items, which did most of the work of holding back the aggregate price increase were principally games, toys and hobbies, cultural services, clothing and sea fares.

Source: Office for National Statistics

With business investment stalling prior to the 31st October Brexit deadline, the UK consumer looks in position to take advantage of lower prices and support the economy through increased spending. The stability of prices also gives the Bank of England some wriggle-room to boost the economy through interest rate cuts, should the Brexit process trigger the need for such a move.

 

Data mining

The headline number of the report by the Office for National Statistics (ONS) shows the prices of goods and services paid by UK consumers rose at an annual rate of 1.7% in August. Reuters had conducted a poll of economists who held a consensus view that the August number would be 1.9%. The August data came in not only lower than expected but also below the July figure of 2.1%. This move points to prices being kept in check, which is significant considering the strength of wage growth and the fall in sterling.

 

 

Source: Office for National Statistics

Economist from the EY ITEM Club, Howard Archer, said:

“Improved consumer purchasing power is particularly welcome news for an economy currently struggling markedly amid major Brexit, domestic political and global economic uncertainties.”

Source: Reuters

 

Wages

Official wages data released last week showed wage growth hit an 11-year high of 4.0% in the three months to July of this year. This is a pace that would normally prompt the Bank of England to tighten rates, but the unknown risks associated with Brexit have so far curtailed any plans to step in pre-emptively.

 

Sterling

The pound has recently recovered from trading as low as 1.19 against the US Dollar. Following a shift in the political balance at Westminster, GBPUSD is back in the 1.24 area. The threat of no-deal Brexit is perceived, for now at least, to be lower than it was mid-summer. The rebound is a recent occurrence, and the inflation data is drawn from August when the plummeting pound would have made imports into the UK more expensive. Raw materials, energy supplies and manufactured goods could have all been part of the process of ‘importing inflation’. Not only did that not materialise, but the inflation number has surprised to the downside.

 

Bank of England

The fall in the inflation rate was forecast by the Bank of England, which thinks the trend is towards the downside. In August, the Bank projected inflation would fall to 1.6% by the end of 2019. This would be a three-year low and shows that, despite the strength of wages and weakness of the pound, the UK economy is a long way from having a problem with runaway prices. The Bank says underlying inflation pressures mean it is still likely to need to raise interest rates over the medium term, assuming Britain avoids major Brexit disruption and the global economy recovers from its slowdown. Events in Saudi Arabia over the weekend demonstrate that these are not necessarily times in which to make ‘assumptions’ about geopolitical events. Whilst the guidance may be for UK interest rates to rise, the latest inflation data opens the door to a move in the opposite direction.

 

Market reaction 

The inflation data was broadly welcomed by the UK markets. The FTSE 100 tends to rally on weakness in sterling due to the profits of UK multinationals being converted into, and reported in, sterling terms rather than the currencies in which they are made. Despite the inflation data suggesting medium-term weakness for the pound, the FTSE 100 held up and was trading flat following the inflation announcement. In the main, traders will be looking towards the announcement on US interest rates — due from the US Federal Reserve later on Wednesday. However, the absence of a shift in equities will be welcomed by the UK authorities.

FTSE 100 (TVC:UKX) — Five-day price chart

Source: TradingView

Sterling was also only slightly moved by the news. The pound has been rebounding off low levels. The recent announcement will reduce some of the momentum of that move and possibly bring about profit. Sterling extended losses after the data and was down 0.3% at $1.2454. UK gilt yields also fell.

The five-day price chart below shows that Wednesday’s inflation data coincided with a relatively small adjustment to the downside, which could have been caused by the inflation data or the more general sell-off after the recent bull-run. The moves were definitely muted as the forex markets showed they are also waiting for the more impactful decision from the Fed.

GBPUSD — Five-day price chart

Source: TradingView

The outlook may be clearer after the Fed announcement. In that regard, Nikolas Papas of InvestingCube.com laid out some of the technical framework when he shared his analysis of GBPUSD on the site:

“Bulls are still in control but the double top formation at 1.25, where also the 100-day moving average crosses, increase the likelihood of a potential correction. On the upside, immediate resistance now stands at 1.2505 — today’s high — while more offers will emerge at 1.2735, the 200-day moving average. On the downside, immediate resistance stands at 1.2437, today’s low, and then at 1.2276 the 50-hour moving average.”

Source: InvestingCube