The pound rose after the release of better-than-expected inflation data on Wednesday that will strengthen the case for the Bank of England to raise interest rates in the future.  While this means that households in Britain will be burdened with the soaring cost of living as petrol and diesel prices have gone up, it is seen as positive news for markets and the pound as it will push the BoE to act.

Inflation data

According to the ONS, headline Consumer Price Index (CPI) inflation rose 1.1% month-on-month in March, more than the 0.7% that markets had forecast. The annual rate of increase came in at a 30-year high at 7.0%, exceeding the 6.7% expected and the 6.2% February figure.

The rise is the fastest in three decades. Core inflation rose by 0.9% in March, as price pressures increased, and this will have to be addressed by the Bank of England.

The chancellor, Rishi Sunak, attributed the rising costs to global supply chain and energy market pressures which could be made worse by the war in Ukraine. He said: “I know this is a worrying time for many families, which is why we are taking action to ease the burdens by providing support worth around £22bn in this financial year, including for the most vulnerable through our household support fund. We’re also helping as many people as possible into work – the best way for families to gain economic security in the longer term.”

Market reaction

Traders reacted by buying the pound as the data boosted expectations for more interest rate hikes, with 140 basis points of hikes expected to be delivered in 2022.

However, some analysts have warned that the pound’s gains might be short-lived as economic growth could slow down due to inflationary pressures which will hit households, consumer confidence and economic activity.

JP Morgan has warned that inflation might not be as positive as some may think and could  have a negative effect on the pound due to stagflation and an economic slowdown.

For households, if inflation moves above the 8% YoY in April and lasts for months after, then people will struggle in an economy that remains vulnerable.

For the coming week, if more data is strong and shows a tight labour market and consistent growth then this will mean that the BoE hiking cycle will continue, offering support to the pound.

Others believe that hiking interest rates will provide no help as inflation is being driven by an external energy shock. There is also the argument that inflation will do the BoE’s job and there is no need for hiking rates as it will destroy demand and recovery.

The outlook for interest rates has then become difficult to predict and this will make things for the British currency more complicated. In terms of inflation, it is expected to fall in 2023, below 2.0% in the second half of next year.

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UK unemployment rate fell to 3.8% in February and wages increased, lending support to the pound.

According to data released from the Office for National Statistics (ONS) on Tuesday morning, UK average weekly earnings rose 5.4% in February. The data reflects persistent wage inflation, which should encourage the Bank of England to raise interest rates again in May. The wage and employment data comes at a time when UK economic momentum is falling, while inflation is rising, and this could push the pound lower.

With higher inflation, weaker consumer confidence and higher credit growth, the outlook for the pound seems disappointing.

UK jobs report

The UK’s unemployment rate fell below its pre-pandemic levels to 3.8%, but these was due to employers hiring less staff and people leaving the labour force. Regular pay fell by 1% over the last year after adjusting for inflation.

Employment rose with 32,485 people currently employed. UK employment rate remained at 75.5%, 1.1% lower than before the pandemic.

The ONS noted that economic inactivity rate increased by 0.2% to 21.4% in December 2021 to February 2022, with 76,000 more people becoming economically inactive, as many were looking after home or family, retired or were sick. Today’s jobs report has shown that 487,000 more people were considered economically inactive, mostly older workers, due to long-term sickness. Long Covid is expected to be the main cause for this increase.

Responding to today’s release of labour data, Minister for employment, Mims Davies, said: “With the unemployment rate returning to the lowest we have seen in nearly 50 years, it is clear our Plan for Jobs has worked – protecting livelihoods and businesses throughout the pandemic. Behind these ONS figures we know this is a difficult time for many workers and families. We’re doing everything we can to help, with our Way to Work scheme which is supporting people coming through the doors of our Jobcentres to move into better paid, higher skilled work. As well as increasing the National Living and Minimum Wage all backed up by over £22bn of targeted investment.”

Ben Harrison, director of the Work Foundation thinktank, said that more government help for struggling households was needed since today’s statistics showed “a mixed picture for the UK’s labour market recovery with employment stationery at 75.5% and unemployment dropping to 3.8%. However, the vacancy rate remains high at 1.3 million, and economic inactivity continues to rise to 21.4%. Crucially, workers and job seekers are being hit by the largest fall in living standards on record as inflation outpaces wage growth. Many are struggling to make ends meet as regular pay growth is at 4% (excluding bonuses) but inflation continues to rise, with the Bank of England predicting inflation will reach 8% in spring and could rise further later in the year.”

Bank of England

The data today is expected to reinforce the case for further interest rate hikes by the Bank of England. Some economists believe the Bank will proceed to hike by another 25bp at its next meeting in May, but they believe the hiking cycle will end there, with no further rate hikes. They noted that the market will begin to adjust its interest rate hike expectations lower and this will hurt the pound.

There are also increasing concerns that the British economy is facing a recession, and this is why the BoE is cautious and less aggressive about tightening monetary policy.

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In worrying times like this, it is important for us to point out that we completely acknowledge the wider implications of international conflict. Our principle duty as a company is to ensure that our clients are aware of all of the factors that affect currency exchange rates, which sadly sometimes includes war. Our thoughts are with everyone who is being affected by this escalating situation, and our currency updates do not intend to diminish, ignore or undermine the true impacts of this conflict.

The cloudy market mood due to fresh western sanctions against Russia and atrocities against Ukrainian civilians has hurt the risk-sensitive pound. Adding to this is the policy divergence between the Bank of England and Federal Reserve, as the latter remains more hawkish and determined to tighten monetary policy. For those exchanging pounds to US dollars or vice versa, the key event will be the Fed minutes released later today at 7pm BST.

The pound weakened since yesterday, despite starting the new week on a positive note, as investors’ confidence was hurt following rising tensions in the Russia – Ukraine conflict, reports of war crimes and western sanctions against Kremlin.

Central Bank divergence

Markets are expecting the Federal Reserve to proceed to aggressive tightening, with the potential to announce both a balance sheet reduction and bigger rate increases in the upcoming May meeting.

The divergent monetary policy outlooks between the Fed and the BoE have kept the pound lower against the US dollar. BoE policymakers remain in a difficult position and have avoided pointing to any further rate rises, as they fight surging inflation and risks to economic growth.

Traders will focus on the Fed March meeting minutes for guidance regarding a rate hike in May. Chairman Jerome Powell has said previously that the minutes will contain details of the bank’s plan for quantitative tightening including the size of the targeted monthly balance sheet reduction.

Market participants expect the balance sheet to shrink by $US2½ trillion, but some analysts have noted that the Fed will be less aggressive, and the US dollar could weaken in response.

The US dollar rose against both the euro and the pound after two US policymakers warned that the Federal Reserve could decide as early as next month to begin shrinking its near-$9trillion balance sheet faster than expected.

Ukraine and Eurozone politics

The euro is lower and pressure on the single currency will continue as the Russia – Ukraine conflict and rising political risks ahead of the French elections persist. The upcoming April presidential election in France and uncertainty about the outcome will weight on the euro.

New sanctions against Russia will have a negative impact on both the euro and the pound. Both currencies will also continue to be under pressure as the war in Ukraine rages on and energy supply risks continue too. The imposed sanctions will affect negatively western countries and Europe in particular. The White House said that the US government and its allies will impose new sanctions on Russian banks and officials on Wednesday and ban new investment in Russia. The head of the European Commission also said that there will be further sanctions including examining energy imports on top of those announced on Tuesday.

Headlines regarding news about the war in Ukraine will influence both the euro and the pound and both will also be sensitive later today to the release of the minutes from the March meeting of the Federal Reserve.

Scotiabank and Credit Suisse economists expect the pound to weaken further. As Scotiabank analysts noted, “widening gilts-UST yield differentials have begun to weigh more clearly on the pound in recent trading” and could even go lower. They added that the pound will weaken further as the “gap between year-end hike expectations widens further.”

The market remains cautious ahead of speeches from Bank of England officials later this Monday. Analysts have noted that any move higher for the pound to US dollar exchange rate will be limited, as Treasury yields have advanced further due to the hawkish Federal Reserve outlook, which could help support the US dollar.

BoE Governor Andrew Bailey’s speech

In particular, markets will focus on BoE Governor Andrew Bailey’s speech at the Stop Scams Conference at 10.05am (BST). Later at 3pm (BST), the Bank of England Deputy Governor Sir Jon Cunliffe will give a speech at a European Economics & Financial Centre seminar.

Bailey said last Monday at an event held by the Bruegel thinktank in Brussels that the situation remains very volatile in relation to May’s interest rate decision. Britain’s economy is expected to slow down amid the biggest shock from energy prices since the 1970s, the governor of the Bank of England has warned. He said that demand from consumers and businesses will also slow down due to the cost-of-living squeeze, with the prices for gas, electricity and other goods and services to continue to soar.

He said: “The shock from energy prices this year will be larger than any single year in the 1970s. The caveat is that the 1970s had a succession of years and we very much hope that would not be the case now. But as a single year, this is a very, very big shock.”

Bank will demonstrate a softer tone and act cautiously

Economists at MUFG Bank believe that weaker growth will force the Bank of England to act cautiously. They stated: “We see potential for the BoE to pause its tightening cycle after hiking in May and August as weaker growth throughout the remainder of the year will provide justification for that and act to weigh on GBP performance. We have revised lower our GBP forecasts based on a more cautious BoE given the weaker growth outlook.”

Consumer Confidence

The higher cost of living and surging food and energy prices have hit UK consumer confidence which is down to its lowest level since the pandemic.

According to a new report from PwC on Monday morning,  there was a “significant and sustained drop-off in consumer sentiment” with its index of UK consumer confidence falling to -20 this month, from +10 last summer. The 30-point drop in the last nine months is the biggest decline in PwC’s survey since Global Financial Crisis in 2008, with households facing the biggest squeeze in decades.

PwC has warned that the sharp drop shows the impact that the cost-of-living crisis is having across the UK. Lisa Hooker, Leader of Industry for Consumer Markets, PwC UK, explained:

“This shift in sentiment is both significant and sudden, with consumer spending expectations moving towards more essential areas at the expense of discretionary items. Businesses that help customers by offering them the options to trade down are more likely to keep their loyalty for when things get better.”

As PwC noted, those businesses that can help consumers now will benefit later, as consumers will remember and reward these businesses. They emphasised that consumers do not tend to switch to cheaper options but look for special offers within the same retailer or hospitality provider, so if such businesses trade down by offering special offers, cheaper brands, or set menus, they will more likely keep their loyal customers when things improve later.

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The pound has gained against the US dollar on Monday due to positive risk sentiment and the release of the Markit Manufacturing and Services PMI data for February. The PMI data has revealed that business activity in the UK private sector has continued to expand at a robust pace in February.

Markets and investors are optimistic that a diplomatic solution to the Russia-Ukraine crisis can be found. Later in the week, US President Joe Biden will meet his Russian counterpart Vladimir Putin. Over the weekend, however, various news channels reported that the US received information that Russia was preparing for military action against Ukraine. If geopolitical tensions escalate, this could weigh on the British pound.

IHS Markit PMI surveys

The UK economy bounced back in February, according to the latest IHS Markit PMI surveys. UK business activity was the strongest since June. With consumer spending increasing as the pandemic restrictions loosened, sectors such as travel, leisure and entertainment saw the highest activity. The flash UK Composite Output index for February came at 60.2, the flash UK services business activity index for February came at 60.8 and the flash UK manufacturing output index came at 57.3.

The PMI surveys also showed that high inflation persisted in February, with higher wages, energy bills and raw material costs pushing businesses’ operating costs higher.

Markit said: “The overall rate of input cost inflation was the steepest since last November and the second-highest since the index began in January 1998. This resulted in another sharp increase in average prices charged by private sector firms, although the latest rise was softer than at the start of the year.”

Bank of England interest rate hike in March

Chris Williamson, chief business economist at Markit, said that the Bank of England could deliver another interest rate hike as soon as March: “With the PMI’s gauge of output growth accelerating markedly in February and cost pressures intensifying to the second-highest on record, the odds of an increasingly aggressive policy tightening have shortened, with a third back-to-back rate rise looking increasingly inevitable in March.” Williamson has also warned that the rising cost of living, higher energy prices and uncertainty could affect the demand outlook and that both the manufacturing and services sectors would need to be closely watched.

Gabriella Dickens, senior UK economist at Pantheon Macroeconomics, said she was reviewing her forecast for UK GDP growth in the first quarter up to 0.6%, and added that the Bank of England will “almost certainly” raise interest rates in March. She noted that the sharp rise in the composite PMI in February indicates that the economy is recovering from Omicron.

JPMorgan economist Allan Monks noted the surge in the UK PMI data and said that while growth is not the Bank of England’s main focus at the moment, February’s PMI indicates “strong momentum in growth ahead of a set of headwinds that are due to intensify from April. To the extent this momentum limits damage to the labour market, we believe that it will further encourage the BoE to continue normalising rates in the coming months.”

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Sterling strengthened following higher than expected inflation numbers. UK inflation jumped to a near-30-year high of 5.4% and economists have noted that inflation will continue to rise.

Inflation is anticipated to exceed 6% in April and come closer to 7% as supply chain issues come to feed through into prices in the shops and domestic energy bills rise up to 50%. The data which was released by the Office for National Statistics will also affect the Bank of England’s decisions, as the Bank is required to keep inflation close to the government’s 2% inflation target and has continually underestimated the recent price pressures. Traders and investors will closely watch the Bank’s meeting in early February, as expectations for an increase in borrowing costs from 0.25% to 0.5% have now increased.

Inflation

UK CPI inflation for December came at 5.4% year-on-year according to the ONS, beating expectations of a 5.2% reading and surpassing November's number of 5.1%. Core CPI inflation was at 4.2%, higher than the market’s expectation for 3.9%. CPI is now above the Bank of England’s target and the highest since the UK first adopted an inflation target in October 1992. According to the ONS, December's strong inflation numbers were boosted by higher prices in transport, food and non-alcoholic beverages, furniture and household goods, and housing and household services.

Bank of England and interest rate hike

The Bank of England raised rates in December as inflation in the UK rose above the 2.0% target and now markets anticipate another rate rise in February. Markets expect the Bank Rate to reach 1.25% by the end of 2022.

Some analysts believe the pound has further potential to rise following strong employment levels and higher inflation, while others believe that it has reached its highest level.

Inflation to rise further

Economists expect inflation to rise more and to peak in the months ahead, as the energy price cap is raised. With prices on the rise and real wages already falling, households will struggle with the cost of living.

Chancellor Rishi Sunak commenting on today’s data said: "I understand the pressures people are facing with the cost of living, and we will continue to listen to people's concerns."

The government has been urged to find solutions to protect those consumers who will struggle the most as prices continue to rise. The CBI has also called the government to provide support to struggling firms, especially energy-intensive businesses. In the coming months, the release of more data may reflect higher costs being passed from firms over to consumers as they try to maintain their company margins. Higher energy prices and tax rises will contribute to the looming cost of living squeeze. The TUC, which includes 48 member unions, has also called the government to come up with a plan to deal with the UK’s cost of living crisis. TUC general Secretary Frances O’Grady said that families are facing higher inflation pressures and slowing wage growth and need more help from the government.

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Pound rose on Monday, with investors focusing on the highlight of the week, the release of inflation data on Wednesday. Sterling had strengthened last week, on Friday, following positive UK GDP data, which came at 0.9%, beating expectations of a 0.4% reading. This has put the UK economy above pre-pandemic levels and helped lift the pound.

In the week ahead, traders will focus on UK inflation and the release of retail sales. If UK inflation rises by more than expected then the pound could go higher, as this may increase the possibility of an interest rate hike by the Bank of England.  

For the UK retail sales, investors expect sales to fall by 0.6% in December, but any surprises could create volatility for the British currency.

UK Inflation

Wednesday’s inflation figures will be the main driver for the pound and the most important release for the UK, for this week. They will come ahead of the Treasury Select Committee meeting where Bank of England (BoE) Governor Andrew Bailey, Deputy Governor Jon Cunliffe, and external members at Financial Policy Committee, Dame Colette Bowe and Elisabeth Stheeman will provide oral evidence in relation to the December Financial Stability Report. The BoE’s Financial Stability Report sets out the Financial Policy Committee's view on the UK financial system’s stability and what actions will be taken to remove any potential risks.

 After rising to 5.1% in November, CPI inflation is expected to rise further in April as utility prices increase, according to economists at Capital Economics. When utility prices rise on 1st April, around 50%, then this will add 2.1ppts to overall inflation pushing it up to 6.9%.

Economists expect that the annual rate of inflation rose from 5.1% to 5.2% in December. This will create sensitivity to the pound, especially if this affects market expectations for the timing of another interest rate rise from the BoE.

Could the pound rise further this week?

The pound could benefit if Wednesday’s inflation data is better than expected and the market strengthens its belief that February is more likely the right time for the BoE to raise the interest rate further. Markets expect a series of interest rates in 2022, an expectation that has already helped boost the pound, and could lend further support if inflation data beats expectations. However, any change in rhetoric by the European Central Bank (ECB) that could be seen as supportive to the euro will act as a headwind to Sterling. The ECB has insisted that it has no intention of raising interest rates in the Eurozone this year but with inflation rising in December, it could begin to accept the need to act in the months ahead.

But with limited news coming out of the Eurozone, analysts have noted that the pound to euro rate will be mainly affected by Wednesday’s inflation figures and any relevant commentary from BoE Governor Bailey and his colleagues when they offer their latest testimony about the latest financial stability report.

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The pound has risen very slightly on Friday (14/01/2022), despite better-than-expected UK data.

UK GDP for November

GDP rose 0.9% m/m in November, above the forecast of 0.4%, while Manufacturing Production jumped 1.1% m/m, surpassing the expected 0.2%. Both figures were higher than the October releases and demonstrate that the UK economy continues its recovery. GDP for Q4 is expected to reach or go beyond the pre-pandemic level (Q4 2019), eliminating any possibility for disappointment for the December GDP report.

The Gross Domestic Product released by the National Statistics measures the total value of all goods and services produced by the UK. It is considered as a comprehensive measure of UK economic activity and as such, if it rises, this has a positive effect on the GBP, while, if it falls, then this is seen as negative for the British currency.

Despite the good news, business groups have warned that the economy remained weak, as inflation has continued to rise, and the Bank of England could further raise interest rates. Suren Thiru, the head of economics at the British Chambers of Commerce, said: “Stronger growth in November is likely to be followed by a modest fall in output in December and January, as consumer caution to socialise and spend, and mounting staff absences sparked by Omicron and plan B limit activity. While the UK economy should rebound once plan B measures are lifted, surging inflation and persistent supply chain disruption may mean that the UK’s economic growth prospects remain under pressure for much of 2022.”

While analysts anticipate stronger growth in 2022, consumer spending will be limited due to the rising cost of living. Wages are expected to go up around 3.5% in 2022, as prices rise.

The chancellor, Rishi Sunak, congratulated the “grit and determination of the British people” and noted how “amazing” it was to see the economy back to pre-pandemic levels in November. He said: “The government is continuing to support the economy, including through grants, loans and tax reliefs for businesses, and our plan for jobs is ensuring people up and down the country have fantastic opportunities. We all have a vital part to play to protect lives and jobs, and I urge everyone to do theirs by getting boosted as soon as you can.”

Johnson under criticism

Prime Minister Boris Johnson is under criticism after revelations that his staff held parties during the Covid lockdown. Boris Johnson is already facing calls to resign from the opposition and some senior Tories after he admitted attending a drinks’ gathering in May 2020. According to the latest news, Downing Street staff held two parties during Covid restrictions with both taking place the night before Prince Philip's funeral. The Telegraph reported that the events took place on 16 April 2021 and continued past midnight. Prime Minister Boris Johnson was not at either party, but the events raise questions about the culture at No 10, Labour's deputy leader Rayner said.

Johnson has urged MPs to wait for the outcome of an investigation into lockdown gatherings by senior civil servant Sue Gray, which is expected next week.

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The pound has slightly dropped from its over two-month high which it reached this Wednesday, but the outlook remains positive with traders expecting additional gains. Researchers at Barclays also anticipate the pound to continue outperforming its major peers over the coming months.

The pound’s retreat today was not driven by any specific economic factor and could be attributed to traders readjusting their trades ahead of the all-important US consumer inflation figures.

Pound’s positive performance could continue researchers say

Markets generally believe that the pound’s strong performance in the first week of the new year was largely driven by expectations for a February interest rate hike and this could continue in the coming weeks and months.

The market now expects a ~75% chance of a second rate hike at the BoE’s February  policy meeting. This has also been further boosted by expectations that the US Federal Reserve will proceed to a faster and earlier interest rate hike cycle in 2022.

With inflation rising in both the UK and the US, markets expect higher interest rates in the US and the UK, which will support the British currency.

UK retail sales

The latest annual Retail Sales Monitor report from the British Retail Consortium (BRC) showed that sales grew, but consumer spending slowed the final weeks of 2021. The British Retail Consortium said that UK retail sales grew by 2.1% in December with growth coming in at 9.9% year on year. Government restrictions slowed spending, but in general the Omicron variant did not have a massive impact as retail sales held up through December. However, January is expected to be a more difficult month for the high street with footfall at UK outlets seen lower in the first week of January.

Businesses in the retail sector have warned that the spread of Omicron and the increasing costs of living could have a significant impact on sales this year.

Bank of England interest rate hikes

While a February rate hike would be the second interest rate rise in just two months, the total number of hikes to be delivered in 2022 is yet unknown and will be a crucial factor in the pound’s performance.

The Bank of England's unexpected December rate hike has led the market to believe that there will be more near-term rate hikes. As it becomes clearer how the Bank is expected to act and how many rate hikes will be delivered over the coming months, the pound will gain further support.

With the Omicron variant slowly subsiding and markets regaining optimism the British currency will also gain traction. As BBC reported on Wednesday, Covid cases in the UK are decreasing according to the daily figures released by the government, with the number of cases confirmed over the past seven days having fallen 13% compared to the previous week.

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Despite Omicron concerns, the pound has hit its highest level against the US dollar since November and its highest level against the euro since February 2020.

Bank of England rate hike

The expectation of inflation rising has helped to push the pound higher as traders now anticipate the Bank of England to hike interest rates in February, after raising them to 0.25% in December. Economists believe that it’s a close call as Omicron is expected to hit economic growth this winter. The economic impact of Omicron might not be huge or long-lasting, but the Bank still needs to tread carefully. While the markets expect the Bank of England to hike rates again at the start of February, some analysts think it might wait a little bit more, until May.

Businesses are facing staff shortages while consumer spending has been much lower in the end of December. Analysts believe that the Bank might wait for more data, and as such a rate hike in May appears to be more likely.

UK Covid cases have peaked

It is beginning to look quite hopeful experts have said, as there are hopes that the UK Covid cases have peaked in all parts of England. New case numbers are starting to fall in the South East and the East of England, and in London. According to official records, as of January 8, new case numbers are beginning to fall in the South East and the East of England, as well as in London, which peaked before Christmas. Cases are rising in other regions but at a much lower pace.

Professor Kevin Fenton, Public Health England’s regional director for London, told the Sky News that the Omicron wave has now peaked in London. He warned that ONS data showed that almost one in 10 Londoners are still infected with the virus and the pandemic is not yet over.

While case numbers and hospitalisations are dropping, scientists have highlighted the significance of vaccines which are believed to have prevented intensive care wards, and the NHS, from being overwhelmed.

The Prime Minister confirmed that ministers are considering reducing the self-isolation period for fully vaccinated people who test positive for the virus to five days from the current seven.

The prospect of a drop in cases suggests that an economic rebound into the second half of Q1 is possible and this in turn will validate the prospect of a February interest rate hike.

Economists have noted that the most negative economic impact of Omicron is the rising number of self-isolation cases and weak consumer sentiment. The combination of the two could further slowdown economic activity.

If there is an economic rebound, then the Bank is expected to raise interest rates and markets are pricing more than a 70% chance of another UK rate rise next month. The rise of US and UK bond yields has also offered support to the pound so far. Sterling remains the best performing G10 currency of 2022.

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