Pound Sterling Higher as UK Prices Rise

The first major data release of the week has proven to be a positive for the British pound.

UK consumer prices rose by 0.1% in the year to May as the majority of economists had been expecting.

This is higher than the previous month’s reading where the UK was confirmed to have fallen into deflation at -0.1%.

The pound sterling has risen against the US dollar, euro and a host of majors following the data.

The pound to dollar exchange rate has fallen to 1.5622 and the euro to pound exchange rate has fallen to 0.7190.

Rising inflation will be seen as a positive for the British pound’s longer-term outlook - the Bank of England can’t ignore rising prices and will react by raising interest rates to ensure a lid is kept on inflation.

Rising interest rates = higher UK exchange rates.

We do however get the sense that much of the moves in sterling's favour are actually more as a result of weakness elsewhere, partucularly with regards to the euro which is dogged by the Greek debt impasse and the US dollar which faces the FOMC on Wednesday. More on these two issues below.

UK Out of Deflation

After a sweet yet fleeting life, deflation is dead.

The ONS has reported prices rose 0.1% in the year to May 2015, statisticians have said rises in airfares are the main culprit behind the rise and could be attributed to the timing of Easter.

However, rising fuel prices were also noted confirming that the period of falling oil prices has come to an end.

“Inflation has been hovering around the zero mark for the past few months, but it has now at least bounced back into positive territory. Mark Carney doesn’t seem concerned and there is little doubt that it will rise towards the end of the year as oil prices climb back up,” says Dennis de Jong at UFX in response to the inflation data release.

de Jong adds that wage growth will start picking up, something that should light a fire under expectations for a UK interest rate rise:

“The UK economic data hasn’t been entirely positive since the general election, yet George Osborne will take particular encouragement about the prospects of significantly higher wage growth.

“People are starting to feel the benefit in their wallets and with continued low inflation likely over the next few months, expect to see plenty of summer holidays booked this year.”

However, analysts at Bank of America have told us they see no prospect of a UK interest rate rise until the US Federal Reserve raise rates.

The prospect of a move in the US will be the main focus for currency markets this week with the FOMC meeting on Wednesday expected to point towards a September rate rise.

 Euro and the Dollar: Fireworks Ahead

Fireworks Ahead

"Absent concrete developments out of Greece, FX markets are starting to get ready for this week's scheduled fireworks. Those fireworks are the June FOMC meeting, of course, and market participants are evidently split on which way policymakers will break. There's either enough improved data in Q2'15 to declare that the slowdown in Q1'15 was transitory, or there's not and the probability of a rate hike this year is low," says Christopher Vecchio, Currency Strategist, at DailyFX.

DailyFX reckon the market seems primed for an explosive move, with several USD-pairs sitting at important technical levels that could determine the viability of breakout attempts.

EURUSD is a particularly curious case, where price has constricted itself into two symmetrical triangles.

"Given the growing threat of a tail-risk event revolving around Greece, and the possibility that the Fed takes on a more optimistic tone about the US economy, one can't help but feel that the massive reduction in Euro short positioning in the futures market (there were 138.0K net-short contracts held by speculators for the week ended June 9, nearly half of the level at the all-time high on March 31, at 226.6K net-short contracts) means that there's a considerable amount of cash on the sidelines that could come into play to dictate a major swing in price," says Vecchio.