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Sterling (GBP) Forecast - Rising Inflation and Lower Wages

Sterling (GBP) Forecast - Rising Inflation and Lower Wages

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GBP Talking Points:

  • GBPUSD await key US jobs data to consolidate a direction.
  • UK inflation continues to rise above the 2% target rate, but GBP volatility could be playing an important role.
  • Unemployment is at the lowest level since 1974 but lower wages are diminishing consumer’s living standards

EURGBP continues to come down from yesterday’s peak seen at 0.8890 after the ECB failed to please dovish investors as a lack of data brings the pair back around the 20-day moving average. The daily RSI signals that the bullish trend is weakening, and a reversal may be in place. GBPUSD saw a small increase in volatility in the morning session as investors eye the much-anticipated Non-Farm Payrolls released at 12.30 GMT, with a possibility that weakening job creation may put downward pressure on the US dollar as markets ramp up interest rate cut expectations during the remainder of the year.

Join our analyst Christopher Vecchio in a live webinar to follow the results of the US NFP and unemployment figures and its impact on the markets.

GBP long-term outlook, rate hikes may follow soon

Whilst the future of the British economy still remains Brexit-dependent, and the outcome of such continues to be very uncertain and unmeasurable, Bank of England (BoE) governor Mark Carney has remained hopeful as he pointed out that the BoE will need to raise rates if the economy continues to perform as expected. UK interest rates have remained at 0.75% since last August.

Longer-term, the Pound (GBP) continues to be under pressure as political uncertainty surrounding Tory leadership contenders and the future of Brexit continues. We can expect to see some volatility around GBP pairs as the race to become the new Prime Minister draws closer, but the direction of the Pound will depend on who is elected and what their views are on Brexit. Any news leading up to the election of a new PM and the future of Brexit will see small spikes in GBP pairs but the downward pressure on the Pound will continue until the Brexit uncertainty is resolved.

Inflation remains high, but wages are not keeping up

Keeping Brexit aside, let’s look at how the two traditional forces behind rate changes have been performing:

Inflation remained above the 2% target in April after it dropped slightly in the first quarter of the year. The increase in prices was in part influenced by the increase in energy prices after the price cap rate was increased in March, which was reflected as core inflation - which excludes volatile prices like energy and food – remained unchanged at 1.8%. Forecasts for the month of May, which are due to be released on the 19th of June, currently stand at 2.2%, showing that economists believe the increase in demand and consumption will continue to push prices higher. The BoE TNS Inflation Survey, released today, shows that expectations of inflation over the next 12 months are running at 3.1%, down from 3.2% in the February survey. As a rule, when inflation increases, and consistently remains above the target threshold, the BoE will employ interest rate hikes to deter consumption and bring down price pressure to a more manageable level.

For most of 2017 and 2018 the inflation rate has remained above the 2% target, reflecting the impact of a depreciating Pound which makes imports more expensive for British consumers. Periods of sustained volatility in the Pound can lead to incomplete readings of inflation. When exchange rates fluctuate the value of foreign goods to local consumers changes, and whilst small customary fluctuations do not have a long-term effect on traded goods, sustained periods of political uncertainty can distort inflation readings. If prices are increasing solely because foreign goods are more expensive then underlying consumption patterns are not changing, which in turn limits the effect of interest rate hikes, the primary tool of Central Banks to control the flow of cash in the economy. With continued Brexit uncertainty weighing heavily on the Pound, some may believe that the efficiency of the BoE’s use of interest rates to control price changes may be limited.

But it is not inflation in isolation that determines the need for interest rate changes, employment also plays an important part.

  • Employment:

The UK jobs market has been showing resilience to adverse circumstances as the unemployment rate for the three months to March fell to its lowest level since 1974 at 3.8%. But despite the employment rate hitting a high of 76.1%, there are less jobs being created than in previous months and nominal earnings growth has reverse its upward trend. Wage increases adjusted for inflation fell to 3.3% in the three months to March from a previous reading of 3.5%. If wage growth doesn’t keep up with inflation the purchasing power of consumers is diminished and living standards fall. Although the effect of Brexit is likely high – March was the original Brexit date and concerns over the future would have kept businesses reluctant to offer higher wages – if wages continue to fall we could see inflation falling from current levels.

Recommended Reading

Hawkish vs Dovish: How Monetary Policy Affects FX Trading – David Bradfield, Markets Writer

Eurozone Debt Crisis: How to Trade Future Disasters – Martin Essex, MSTA, Analyst and Editor


--- Written by Daniela Sabin Hathorn, Junior Analyst

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