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Will the Pound's Brexit Woes be Overshadowed by CPI, Implications for BOE Policy?

Will the Pound's Brexit Woes be Overshadowed by CPI, Implications for BOE Policy?

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- UK inflation tops +3% year-over-year, essentially locking in a BOE rate hike next month.

- US Dollar sees a barren economic calendar ahead of it the next few days.

- Retail trader sentiment suggests the near-term outlook for the US Dollar is neutral.

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The British Pound has had a volatile past two weeks, thanks mainly due to a wave of unsettling news surrounding UK Prime Minister Theresa May’s leadership and her government’s ham-fisted handling of the Brexit negotiations.

Quietly, amidst the noise, BOE rate hike expectations have been slowly pricing in a greater likelihood of a 25-bps rate hike at the BOE’s November meeting. At the beginning of the week of the BOE’s September policy meeting, rates markets were pricing in approximately a 20% chance of a move in November; at the end of that week, odds were near 65% and GBP/USD was near 1.3600.

Now, even though GBP/USD is closer to 1.3200, rate hike odds have tightened up to a 75% chance of move. With the September UK CPI report having been released earlier today and showing headline inflation at +3% y/y, a shift in the market’s focus from the GBP-negative Brexit news flow to the GBP-positive inflation picture and its implications on incoming BOE monetary policy should limit Sterling losses in the near-term.

Chart 1: DXY Index Daily Timeframe (May to October 2017)

Will the Pound's Brexit Woes be Overshadowed by CPI, Implications for BOE Policy?

Elsewhere, the US Dollar is gaining ground today, holding the uptrend from the September swing lows in the DXY Index in the process. But the past two weeks have been anything but easy for the greenback. The US Dollar was riding high coming into October thanks to Fed rate hike expectations sharply repricing the odds of a move in December.

Yet since Friday, October 6, nothing seemingly has gone right: the headline US Nonfarm Payrolls report posted its first negative reading in seven years; US President Trump’s tax reform plan hit a wall amid more infighting in the Republican Party; and the September US CPI report reinforced the growing notion that persistent readings below the Fed’s medium-term +2% target may be structural rather than transitory – a feature, not a bug, of the US economy in 2017 and beyond.

Recall that CPI rose +0.5% vs 0.6% exp (m/m) and the +2.2% vs +2.3% exp (y/y). The Core readings (ex-food and energy) also missed expectations. A speech by Fed Chair Janet Yellen at the end of the coming week is the only event on the DailyFX Economic Calendar that warrants a ‘high’ importance tag, rendering the US Dollar’s fate in the next few days subject to the tonality of comments from Fed speakers rather than data.

Read more: FX Markets Turn to Inflation Data from New Zealand, the UK, and Canada

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

To be added to Christopher's e-mail distribution list, please fill out this form

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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