Sterling dips despite inflation hitting near four-year high

May 16, 2017 10:18 AM

Equity markets in Europe are trading a little mixed on Tuesday, offering little direction for US futures ahead of the open on Wall Street, while commodities are broadly in the green as oil looks to extend its winning run to five straight sessions. There have been some interesting moves in currency markets this morning, with sterling being particularly volatile on the back of some interesting inflation data. 

This morning’s UK CPI data caused quite a stir for the pound, with the spike in headline and core inflation in April initially sending the currency higher before almost immediately spiraling lower. As always, there’s a number of things to consider here, which would explain such a strong reaction. The above expectation spike in inflation is typically bullish for the currency, especially when the rate is already above the central bank’s target. Add to this the sheer size of the jump and the BoEs acknowledgment last week that “some MPC members would need relatively little upside news on growth or inflation to consider voting for tighter policy” and the initial spike will perhaps seem justified.

That said, there are other things to consider here, not least the fact that Easter this year fell in April rather than March, therefore the year on year comparison is naturally skewed to the upside. The 18.6% increase in air fares which largely contributed to the rise in transport prices is a clear indication of this. The other thing to consider here is that the BoE will likely have been aware of the spike in April when it released its new forecasts and made its decision last week, so from a monetary policy perspective, little has probably changed.

Finally, with the pound already struggling around 1.30 against the dollar, the sell-off that followed to levels well below where it was prior to the release is an indication of an exhausted rally that’s possibly crying out for a correction. Given the size of the moves we’ve seen over the last month, this could easily be what we’re seeing, having failed repeatedly at the recent highs.

The euro, on the other hand, has had a much more positive start to the day, breaking and holding above 1.10 against the dollar to trade at its highest level in six months. The ZEW economic sentiment figures were broadly supportive for the euro – despite the pause that initially followed it – with economic sentiment in Germany rising, albeit less than expected, while the euro zone as a whole rose to a near two-year high. This morning’s break could be significant for the pair, with 1.1125-1.1150 being the next big test for the pair. 

There’s still more to come on the data front, with building permits, housing starts, industrial production and capacity utilization figures all due for the United States.

About the Author

Craig Erlam is senior market analyst at OANDA who also writes for OANDA’s Market Pulse site,