Bank of England’s Inflation Report Looms Large for UK's Sterling

Above: Bank of England Governor Mark Carney's appearance at the quarterly Inflation Report will be key to GBP direction. (C) Pound Sterling Live 2015.

“Consumption has been the predominant driver of GDP growth recently; hence the path of average weekly earnings is important not just for inflation, but for growth too.” – Sebastien Cross at Bank of America Merrill Lynch Global Research.

The British pound (GBP) will be tested on Thursday with the February quarterly inflation report being released at the Bank of England.

According to a briefing, held at Bank of America Merrill Lynch Global Research (BofA), inflation at the end of the forecast horizon will be indicative of the BoE’s current thinking.

Another point to focus on will be the BoE’s earnings growth expectations.

Near-Term Inflation Lower, But this Does Not Matter

January’s release of CPI for December read at 0.5% - the Bank of England had forecast a reading of 1% showing just how far off estimates economists at the central bank are.

Oil has fallen $25 further since November’s QIR ensuring the near-term part of the profile will likely be considerably lower.

The latest MPC minutes gave us an indication of their more recent forecasts, stating:

“CPI inflation was expected by Bank staff to reach a trough of around zero in March, as lower oil prices fed through to petrol prices, with a roughly even chance that it would temporarily dip below zero at some point in the first half of 2015”.

Further out along the forecast profile, Kristen Forbes’ speech suggested the MPC see a steeper inflation bounce back than before, leading to expectations of a more S-shaped profile.

“Where inflation is at the end of the forecast horizon is perhaps most indicative of the BoE’s current thinking on policy setting,” says Sebastien Cross at BofA.

According to Cross, a forecast below target, and the BoE may be considering further easing (although we attach little risk to this).

“Above target, and given that market interest rates are used in their forecasts, this would be equivalent to the BoE telling the market that their current expectations of rate hikes are too dovish, with the BoE expecting a sooner and steeper rate hiking profile,” says Cross.

This seems more likely say BofA.

The other topic of interest is the BoE’s wage growth expectations.

“Consumption has been the predominant driver of GDP growth recently; hence the path of average weekly earnings is important not just for inflation, but for growth too,” says Cross.

Average Weekly Earnings have strengthened since the last QIR and the labour market has tightened.

However the MPC has highlighted concerns in their latest minutes that weaker near-term inflation might feed into inflation expectations and consequently earnings growth.

Carney Bullish on Wage Growth

Ahead of the Inflation Report Mark Carney has come out and sounded a bullish tone on UK wage growth.

“In the U.K. we’ve had a lot of job creation, not a lot of productivity, but a lot of job creation and relatively muted wage performance,” Carney said in Istanbul on Monday. “We’re just starting to see the turn in wages that we need for a sustainable recovery.”

“Later this week I’ll have an exchange of letters with the chancellor which explains how we intend to get inflation back to target from below target for the first time,” he said. “What’s important there is transparency, clarity and timeliness of that return to target.”

Fresh Content CW

Pound Dollar Forecast: Downside potential then exists to 1.4800

Lucy Lillicrap, FX risk management solutions at AFEX

Insufficient evidence exists to confirm this up-leg from 1.4950 is anything other than corrective only and even if Sterling values continue to correct or at least consolidate for several more days another foray below 1.5000 remains readable going forwards.

Downside potential then exists to 1.4800 (a prior notable reactive low) - a break of which would allow for a move towards 1.4500, if not 1.4000, before more obvious buying interest is encountered. In the meantime selling pressure has already emerged around 1.5350 and given additional resistance at 1.5550 recovery potential looks limited.

NB: additional base work might conceivably improve the current GBP negative environment but otherwise broad technical indicators point to renewed GBP weakness heading into Q2 2015 at least before any sustainable recovery becomes readable again.