Eyes on Inflation: Pound and Euro Face up to Key Data Release which Will Drive Respective Central Bank Policy

Inflation data out of the UK and Eurozone will form the economic focus for the Pound-to-Euro exchange rate on Tuesday, October 17.

The UK’s Office for National Statistics report headline CPI inflation for September hit a five-year high having risen 3.0%, data that proved supportive for Sterling.

The data is consistent with market expectations and maintains the view the Bank of England has reason to pursue higher interest rates to counter inflation which is now running a full 1.0% above the target level they are mandated by law to maintain.

Indeed, Governor of the Bank Mark Carney will have to write a letter to Chancellor Philip Hammond if inflation exceeds a 1.0% deviation explaining why inflation is so high and what measures the Bank intends to pursue in order to counter the rise in prices.

Economists expect this to be the case next month as inflation is forecast to continue rising above 3.0%.

The data cements the view a November interest rate rise of 0.25% is likely at the Bank of England, which will support the Pound we believe.

At the time of writing, GBP/EUR is quoted at 1.1278, up 0.38% from its opening level. "For now well supported central bank monetary policy expectations should put a floor below the currency," says Manuel Oliveri at Crédit Agricole.

Above: Sterling has been rising against the Euro since the start of Asian trade on October 17.

While annualised inflation read at 3.0%, monthly inflation read at 0.3% which is also exactly where markets were forecasting it to read.

Core CPI - a measure of home-grown inflation that excludes imported inflation costs - also met expectations by reading at 2.7%.

"The main contributors to the increase in the rate were rising prices for food and recreational goods, along with transport costs, which fell by less than they did a year ago," say the ONS. "These upward effects were partially offset by downward contributions from a range of goods and services, in particular clothing prices, which rose by less than they did a year ago."

Above: UK inflation trends higher to levels last seen in 2012.

“Our expectation that inflation will peak at about 3.2% in October means that Governor Carney will have to get out his letter-writing pen next month to explain to the Chancellor why inflation has deviated by more than one percentage point from the 2% target,” says Paul Hollingsworth at Capital Economics. “However, we don’t anticipate he will be writing letters for long. Indeed, we think inflation will be back below 3% by the end of this year.”

Doors Open to Interest Rate Rises at the Bank of England

The Bank of England has communicated discomfort with current levels of inflation, and has indicated interest rates are likely in the near-term in order to ensure inflation heads back down to their mandated target at 2.0%.

The promise of higher interest rates has boosted the Pound as currency’s tend to appreciate heading into interest rate hiking cycles. When the Bank warned of rate rises at their September the Pound embarked on a rally against the Euro, Dollar and majority of major global currencies over the duration of the month.

“In the UK, we are due to get the CPI inflation print for September but the release should not alter the Bank of England's members' views on the economy significantly and hence we still expect a 25bp Bank Rate hike next month,” say Danske Bank in a briefing ahead of the release.

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Eurozone CPI Central to ECB's Tapering Plans

Eurozone inflation released by eurostat meanwhile saw all numbers hitting economist expectations ensuring the impact on the Euro was neutral.

Annualised CPI for September read at 1.5% while monthly inflation read at 0.4%.

The data is consistent with the European Central Bank announcing it will begin to withdraw its monetary stimulus in either October or November.

The move sees the Bank tapering its printing of up to €60BN a month; but the withdrawal is largely reliant on the assumption inflation is rising back to the 2.0% level, which today's data confirms is more or less underway.