A sharp slowdown in the UK inflation knocked the pound down. The chances of raising the interest rate in September collapsed from 75% to 50%, the UK bond yield dropped, and the GBPUSD hit the lowest level since the beginning of April. However, perhaps the Bank of England’s hawkish pause, rather than monetary tightening, will save sterling.
The slowdown in consumer prices to 6.7% in August amid rising oil and gasoline prices looks surprising. Bloomberg experts predicted an acceleration of CPI to 7%. Core inflation sank even deeper — from 6.9% to 6.2%, prices for services — from 7.4% to 6.8%. The BoE’s 14 acts of monetary tightening have their effect, making the Table Mountain model described by Huw Pill much more likely.
The Bank of England’s chief economist believes there are two options. The first is to continue hiking the Bank rate, after which it will have to be sharply reduced from its peak. Another scenario is to leave the rate at a plateau for a long time. Supporters of the first approach point to the record growth in wages and believe that the BoE will nevertheless raise the rate in September to 5.5%. Their opponents point to the British economy’s weakness and the central bank’s reluctance to bring the country into recession.
Dynamics of inflation, wages, and BoE rate
Source: Bloomberg.
In fact, the situation looks as if the worst is over. The earnings outstripping inflation leads to an increase in real wages, which creates a tailwind for the economy. At the same time, these indicators align with the Bank rate, which proves the effectiveness of monetary policy. The UK no longer looks like the worst performer in Europe; its core inflation is lower than in Germany. This circumstance could open the door to an inflow of investment and strengthen the pound.
Dynamics of core inflation
Source: Bloomberg.
The main thing now is whether the Bank of England will act wisely at its meeting on September 21. And again, it has two excellent examples. The ECB raised rates and, at the same time, signaled the end of the monetary tightening cycle. As a result, the derivatives market began to include expectations of a dovish shift in the quotes, which caused the euro to fall. It doesn’t look like the best option for a central bank that is struggling with high inflation.
In contrast, the Fed took a hawkish pause, pointing to a long process of keeping borrowing costs at a plateau. The US dollar rose against its peers, and financial conditions tightened.
Weekly trading plan for GBPUSD and EURGBP
I believe that whether the Bank of England raises the interest rate to 5.5% or not, communications will matter. If Andrew Bailey can convince investors that Pill’s Table Mountain model will work out, the sterling should stabilize. I suggest selling the EURGBP when it falls below the support at 0.8655. GBPUSD shorts entered at 1.2535 could be closed in the zone of 1.2265-1.23, and one could go long. However, the BoE may fail.
Price chart of GBPUSD in real time mode
