UK Inflation: British Pound Rallies Despite 0% Reading

The pound sterling remains firm after the release of inflation data for August on the 15^th of September 2015.

Inflation is important for UK exchange rates in that it is a key concern for the Bank of England who will seek to dampen inflation through interest rate rises. Higher interest rates in turn attract currency flows that support the exchange rate.

Inflation for August read at 0% confirming no-flation is still with us.

Markets had been expecting a reading of 0% ensuring the pound sterling exchange rate complex has maintained the strength it started the day on.

According to Dennis de Jong at UFX, “some observers had hoped to see inflation rising, providing the Bank of England with the impetus to raise interest rates sooner rather than later.

“However, the results released today will ease pressure on the BoE to intervene, allowing governor Mark Carney to wait and see the impact of the mooted US rate rise later this week. The Bank’s inflation target is two per cent, which may prove difficult to achieve in the current climate of low crude oil prices and a strong pound.”

Meanwhile UK wages are growing at an annual rate of 2.5% which is lifting household spending, and supporting those who want to avoid the risks of waiting too long to begin raising rates.

"In short, there’s no clear winner in the argument for or against raising rates today, and risks to global growth over the next 12 months have increased, making forecasting how the economy will perform in that time all the more difficult," says Andy Scott, an economist with foreign exchange brokers HiFX.

Sterling was largely unchanged following the release which was in line with forecasts. It has fallen by over 2% against both the dollar and the euro after economic data for August showed the economy lost some momentum, leading to scaled back rate hike expectations.

The pound to euro exchange rate is trading above 1.3650 following the data release.

The pound to dollar exchange rate is trading at 1.5443.

Why has the Pound Strengthened?

The GBP was broadly higher following what would otherwise be neutral to negative news.

David Lamb, head of dealing at the foreign exchange specialists FEXCO, explains:

"The sudden disappearance of inflation has scotched any suggestion that the Monetary Policy Committee's surprisingly hawkish minutes presaged an imminent interest rate rise.

"While the Bank of England was hardly teeing up a rate hike for this year, the return of noflation will ensure the idea is booted firmly into the long grass.

"To be fair, there is little in this CPI figure to surprise the Bank. Falling oil prices have once again dragged inflation back to zero; but this is likely to be a short-term effect, and the Bank's longer-term projections still stand. Gentle inflationary pressure should necessitate a rate rise only by the middle of next year.

"So while Sterling watchers will take no solace from the conclusion that a rate hike remains many months away, the Pound has inched upwards following this morning's inflation announcement.

"Sterling's modest relief rally is being driven not by interest rate hopes, but by the reassurance that the Bank's plans have not been blown off course."