British Pound Could Jump Towards 1.9750 If UK CPI Jumps Above 3.0%

What Are The Markets Facing?

On Tuesday at 4:30 EDT, an expected rise in the UK consumer price index above 3.0 percent will force Bank of England Governor Mervyn King to write a letter to Chancellor of the Exchequer Alistair Darling explaining how he plans to bring CPI back to their 2.0 percent. In fact, UK CPI is anticipated to rise to an annual pace of 3.2 percent – matching a 26-year high – from 3.0 percent. The BOE cut rates as recently as April 10 by a quarter point to 5.00 percent, but the Monetary Policy Committee now holds a resoundingly hawkish bias. Indeed, the minutes from the BOE’s May policy meeting showed that the MPC thought that cutting rates would “make it more difficult to keep inflation expectations in line with the target,” and while “economic activity was likely to slow…some slowing in the growth rate of output was likely to be necessary for inflation to settle close to the target around two years ahead.” Furthermore, the MPC cited concerns that the public would get the impression that a rate cut was an effort to “stabilize output growth rather than maintaining its focus on the inflation target.” Signs of rising inflation pressures are everywhere, as UK producer prices rose 1.6 percent in April, the biggest gain since record-keeping began in 1986. The sharp rise drove the annualized level up to 8.9 percent, marking the ninth consecutive month that prices accelerated. All ten categories saw prices increase on the year, led by a 28.5 percent surge in petroleum products on the back of record oil prices, which hit a fresh intraday record of $139.89 a barrel on Monday. As a result, there are upside risks for the UK CPI report, and the news should be very market-moving, especially ahead of the release of the BOE’s June meeting minutes on Wednesday.

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Bonds – Long Gilt Futures

Long Gilt futures have bounced from support at 103.60, but upcoming UK CPI data could send the contract plummeting lower. Indeed, CPI is expected to hit an annualized rate of 3.2 percent, which is well above the BOE’s 2.0 percent target and will force BOE Governor King to write a letter to the Chancellor of the Exchequer explaining how he plans on bringing CPI back to target. As a result, Gilts to plunge toward the July 2007 low of 102.90. On the other hand, surprisingly soft CPI readings could lead the contract t surge above 104 and toward resistance at 105.40.

Written by Terri Belkas, Currency Analyst for DailyFX.com

Questions? Comments? E-mail: tbelkas@dailyfx.com