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UK CPI Unexpectedly Drops; Pound Extends Declines

By Jonathan Granby
12 July 2011 08:58 GMT

THE TAKEAWAY: CPI eases > Zero chance of BoE action > Pound drops

UK consumer prices in June slid 0.1% from May amid expectations of a 0.2% rise marking the first contraction in consumer prices since July 2010, the reading is unlikely to be the first sign that white-hot inflation in the UK is finally beginning to ease. The annual figure came in at 4.2% amid forecasts of 4.5%, showing a marked decline from the 30-month peak posted last month. The annualized core CPI reading also declined to 2.8%, its second consecutive decline off the frothy peak posted in April of 3.7%.

Even though CPI is generally regarded as one of the most crucial and pivotal of the domestic data releases its impact in markets has been slowly but steadily reduced in lieu of the Bank of England’s action in recent months. The central bank has made plain that they expect inflation to worsen before getting better and indicated that they have no plans to take action to tackle the current blip in consumer prices. The MPCs position was improved a great deal this morning and the intense pressure which they are under to take action will likely ease somewhat.

Despite this surprising reading the MPC is likely to maintain its outlook and this better than expected reading is probably a one off and not the beginning of a real decline in CPI back toward the central bank’s 2% target. We may be spared the 5% forecast by the governing council in their meeting minutes but CPI could still reach higher before turning down again in a more structured, medium-term fashion. The Office for National Statistics (ONS) noted that the biggest downward pressure can from falling electronics prices while the largest upward pressure was from food and drink.

UK_CPI_Unexpectedly_Drops_Pound_Extends_Declines_body_gbp.png, UK CPI Unexpectedly Drops; Pound Extends Declines

Despite having dumped 2% already this week we don’t see this outcome changing the trajectory of Gbp/Usd in the coming sessions and the downside continues to look vulnerable. The spike down to 1.5780 is a fresh 5-month low and will likely only serve to present a near-term downside target for bears to drive at. While there is some support around the 1.5800 level if this support is cleanly broken we could see a move back down toward 1.55 region as the US dollar continues to surge as market jitters drive safe haven buying. Additionally, any die-hard bulls who were hoping that perhaps an uber-strong CPI reading would force the central bank’s hand are likely to finally throw in the towel.

Written by Jonathan Granby, DailyFX Research Team

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12 July 2011 08:58 GMT