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British Pound Risks Near-Term Correction on Rising U.K. Inflation

British Pound Risks Near-Term Correction on Rising U.K. Inflation

2016-04-09 00:17:00
David Song, Currency Strategist
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British Pound Risks Near-Term Correction on Rising U.K. InflationBritish Pound Risks Near-Term Correction on Rising U.K. Inflation

Fundamental Forecast for British Pound: Neutral

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The Bank of England’s (BoE) April 14 policy meeting may spur a limited market reaction as the central bank is widely anticipated to retain its current policy ahead of the referendum in June, but signs of sticky U.K. inflation accompanied by dovish comments from Fed officials may generate a near-term rebound in GBP/USD as U.S. interest-rate expectations falter.

Even though the BoE is largely expected to preserve a wait-and-see approach throughout the first-half of 2016, Governor Mark Carney and Co. may sound more hawkish this time around especially as the core U.K. Consumer Price Index (CPI) is projected to uptick to an annualized 1.3% from 1.2% in February. Indeed, heightening price pressures along with the depreciation in the sterling may foster increased concerns of overshooting the 2% inflation target over the policy horizon, but the risk of decoupling from the European Union may generate another unanimous vote to retain the record-low interest rate even as the Monetary Policy Committee (MPC) remains upbeat on the U.K. economy.

At the same time, the fundamental developments coming out of the U.S. may put increased pressure on the Federal Reserve to normalize monetary policy as Retail Sales are projected to rebound in March, while the core rate of consumer-price inflation is projected to hold steady at an annualized 2.3% in March. Even though the world’s largest economy approaches ‘full-employment,’ fresh rhetoric from New York Fed President William Dudley, Dallas Fed President Robert Kaplan, Philadelphia Fed President Patrick Harker, San Francisco Fed President John Williams, Richmond Fed President Jeffrey Lacker, Atlanta Fed President Dennis Lockhart, Chicago Fed President Charles Evans and Fed Governor Jerome Powell may highlight a further delay in the normalization cycle as the central bank continues to monitor the external risks surrounding the region.

With that said, concerns of stronger U.K. inflation paired with more dovish remarks from Fed officials may generate a short-term correction in GBP/USD as the pair consolidates with the March range. However, headlines fueling fears of a U.K. exit may push the exchange rate back below the 1.4000 handle as a departure from the EU could spur a material shift in the monetary policy outlook even as the BoE continues to argue that the next move will be to remove record-low borrowing-costs.

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