Market News & Insights
13 December 2016

Sterling Eyes Inflation for Clues of Strength

Despite a pop higher in oil prices to start the weak, the broader risk environment took a breather ahead of key central bank meetings this week beginning with the Fed tomorrow, amongst another host of rate decisions on Thursday including the BOE. Oil began the week up as high as 6.5 % during the European session following output caps from Non OPEC nations and this helped support European assets which rose to their highest levels in 11 months, while still floating on the ECB’s support following the extension of their asset purchase program last week.

The EUR was firm through the early part of the morning session but lost ground to GBP as we entered the afternoon, while the USD was weaker across the board, losing ground to the EUR, JPY and GBP on the day, the USD index was down almost 1% at one stage before closing the day .7% lower. Stocks in the US struggled to advance and put a halt to the run of record highs we’ve seen over the last month. While losses were minimal across indices (only the Dow advanced) attention continues to be on the Fed on Wednesday and caution may be the name of the game until then. Donald Trump once again managed to wipe billions off a listed company’s stock by complaining about costs, this time Lockheed Martin were in the firing line, following his tirade against Boeing last week. Overnight better than expected Chinese data had a mixed impact, Chinese indices were mixed, the Nikkei traded higher as the JPY gave back some of yesterday’s gains and this morning European bourses are mostly in the green.

The pound has managed to find itself a firm base in recent weeks and has since been building on this. While we still feel GBP is fragile and exposed to volatile downside around Brexit headlines, the case for a stronger pound has been compelling and one we have been arguing for a couple of months, especially pre Article 50 because for many there are no barriers to trade (yet) it is just business as usual, only with GBP significantly depreciated and lower interest rates. The fallout of those two effects however has been a refocus on inflation, the BOE had struggled for years to find any meaningful traction towards their 2% inflation target however since Brexit, rate cuts and a 20% depreciation in GBP, with fuel prices now also on the rise, the BOE may well be getting concerned inflation may run well above its 2% target, and they have already indicated their willingness to accept inflation above their horizon target.

The key question is how quick will it get there? Today’s CPI inflation readings will provide us with some colour on this. The headline rate is expected to rise to 1.1% form .9%, while the core reading is due to rise to 1.3% from 1.2%. Anything higher will favour additional GBP strength as it impacts the BOE’s ability to ease further. There is no change expected from the BOE on Thursday, but should Brexit not have such a significant impact on output next year, the BOE may well find themselves in a position where hiking rates is back on the agenda. Time will tell, but for now GBPUSD upside is favoured towards 1.2800, while EURGBP is looking under pressure with recent lows back towards .8300 area is looking likely.

It is a quiet calendar in the US session, but focus remains on tomorrow and we may well see markets take a consolidative approach around USD pairing until then. EURUSD also looking like it wants to retest lows towards 1.0500 where we may see support, while any progress above 1.0700 area quickly runs into sellers. These are the key area’s to take advantage of and a break either side should favour acceleration.