United Kingdom inflation surprise as prices spike again

GBP  USD Retail Sentiment

GBP USD Retail Sentiment

Morgan Stanley Research: Our economists expect the BoE vote to remain unchanged this week, with a 7-2 split in favour of keeping rates on hold.

Whilst this news clearly demonstrated that some aspects of the "Aussie" economy are gaining momentum, the ongoing stagnation of wages, housing boom and rising cost of utilities remains problematic, particularly in assessing the likelihood of a rate hike from the Reserve Bank of Australia (RBA). Could we see a series of slow and gradual rate hikes a la Federal Reserve, before the BOE concentrates on its balance reduction programme? Is now the time for the governor to put his money where his mouth is and actually vote for a rate hike?

Mark Nash, head of global bonds at Old Mutual Global Investors, says the MPC's surprisingly hawkish tone shows the market got it wrong, "failing to price in any hikes meaningfully in the near term".

Pressure on real incomes is particularly hitting public-sector workers, who have had pay increases capped at 1% since 2013.

The pound has jumped more than 100 pips and is now trading at 1.33 against the dollar. The MPC may also well warn once again that interest rates are likely to rise earlier and a little faster than markets now expect - and indicate that businesses and consumers need to take this possibility on board.

Earnings are tipped to grow 2.3% from a year earlier in July, up from 2.1% in June.

Bets on the Bank of England increasing interest rates increased this week after inflation climbed to 2.9% in August, matching the highest pace in four years.

"Lagging wages makes it more likely the Bank of England will look through rising inflation when it decides on interest rates this week", said Ed Monk of fund manager Fidelity International.

Other periods of sterling strength since then include: November last year (FTSE -3 percent, MSCI +2 percent); mid-March through end-April this year (FTSE -3 percent, MSCI +1.5 percent); and the last three weeks (FTSE -1 percent, MSCI +2.5 percent).

Separate data from the ONS showed that factory-gate inflation accelerated to 3.4 percent in August from 3.2 percent in July.

It is widely expected that the BoE will leave interest rates stable at this meeting, though investors have increasingly begun to expect that the bank could be inching closer to a rate hike. It is also likely the central bank is not happy with the large fall in sterling on a trade-weighted basis, either. We had been mentioning over the past couple of days in our forecasts that the underlying strength of the pound was palpable and it is important for the traders to take note of that.

GBP/USD found support below 1.3200 in late US trading on Wednesday and again at the European open on Thursday as caution prevailed ahead of the interest rate decision.

Expectations of a more hawkish message from the Bank of England have been at the heart of a recent steadying of the pound, sold heavily in the aftermath of Britain's decision to quit the EU.

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