All eyes will be on the Consumer Price Index (CPI) release on Tuesday as markets try to gauge whether UK inflation is headed in a direction that could invite scrutiny at the Bank of England.
Analysts are forecasting a reading 0.4% for March, a shave higher than the 0.2% registered in the preceding month.
Anything above this could well aid the = under-pressure British pound which has been in decline since December 2015.
Indeed, we have recently reported warnings that the decline could even take the pound to euro exchange rate to 1.10 by mid-year; levels last seen in 2011.
Nevertheless, we believe the British pound is oversold at current levels and would look for some kind of pullback to balance the markets.
A trigger for such a move would be stronger than forecast inflation numbers.
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Why Inflation Matters
The Bank of England’s mandate is to deliver “price stability” which is translated into keeping inflation at 2%; a level that reflects healthy economic expansion while not being a threat to our pockets.
The achievement of this inflation level can be achieved through the manipulation of interest rates; lowering interest rates tends to stimulate the economy and thus ensure inflation stays buoyant.
Raising interest rates can achieve the opposite effect if the economy is deemed to be at risk of over-heating.
The by-product of all this are moves in pound sterling; the GBP tends to rise alongside interest rates as demand is stimulated amongst international investors seeking higher returns on their capital.
Will the Pound Receive a Positive Surprise?
The question now is whether UK inflation is in fact growing at a pace to warrant higher interest rates.
“In the UK, measures announced in last month’s Budget will help to boost CPI
inflation this month,” say Lloyds Bank in an economic briefing to clients.
Furthermore, analysts are expecting the inflation rate to edge higher as oil prices start to creep up.
In fact, the oil producers’ meeting to discuss an output freeze on 17th April looms as a key date for the oil price outlook.
“While the ‘core’ rate is significantly above the headline measure, it is still well below the BoE’s inflation target. This is also expected to pick up this month as sterling’s recent slide starts to feed through to import costs,” say Lloyds.
If inflation numbers are indeed above expectations then we could well see the pound find some support.
However, we would expect any gains to be short-lived as we note the pound faces a chronic confidence problem stemming, no surprises here, from the upcoming EU referendum.
As such, those with outstanding euro payments should jump on any recovery in sterling as it will likely prove fleeting in nature.