British Pound Defends Gains Against Euro & Dollar as UK Inflation for March Comes in on Target

• Pound to Euro exchange rate: 1 GBP = 1.1714 EUR
• Pound to Dollar exchange rate: 1 GBP = 1.2433 USD

Pound Sterling was seen near recent highs on Tuesday, April 11 after UK inflation data for March failed to throw up any disappointments.

The ONS reported that CPI inflation edged up 0.4% in March, taking the annualised gain to 2.3%. This is what markets were forecasting and it is unchanged on the previous month's reading.

The important core CPI figure actually underwhelmed coming in at 1.8% as opposed to the 1.9% forecast by markets.

Recall that this is the number the Bank of England are arguably more interested in as it is a good proxy for underlying economic activity.

“The UK’s consumer price index remains some way above the Bank of England’s 2% target, though Mark Carney and Co may be somewhat relieved to see that prices haven’t continued to rise," says Paul Sirani, Chief Market Analyst at Xtrade. "It marks temporary respite from soaring inflation following the post-Brexit collapse of the Pound, with a late Easter and fuel prices being partly responsible for the pause."

Were the figure to have jump above 2% then the market would have increased bets that the Bank would bring forward an interest rate rise; this would certainly have been a positive for the Pound.

Following the release the Pound to Euro exchange rate edged higher to 1.1731, having seen a low of 1.1795 earlier in the day.

The Pound to Dollar exchange rate is at 1.2436, having seen a low at 1.2402 earlier in the day.

"We would not read too much into today’s release since the drop in inflation is likely to be temporary and inflation is likely to rise further over the course of this year," says a note from UniCredit Bank, "we expect an annual average of 2.4% for the UK headline CPI in 2017."

More prices rises are therefore likely and this could well support Sterling longer-term, but for now, the bulls will have to wait.

Inflation Forecast to Peak at 3%

Analysts believe the fall in the value of Sterling since the June referendum should continue to feed through into higher consumer prices in the quarters ahead.

Indeed, the latest producer prices figures showed that cost pressures remained strong at the start of the production pipeline. Indeed, annual input price inflation stood at an elevated 17.9% in March.

Factory gate prices rose by a smaller 3.6%, suggesting that firms are absorbing some of the increase in costs by allowing their margins to be squeezed.

This should help to limit the ultimate impact on CPI inflation as goods prices feed through the supply chain.

"All told, we think that CPI inflation will peak at just over 3% before the end of 2017," says Ruth Gregory, UK Economist at Capital Economics.

What is Moving Inflation in the UK?

The main upward contributions to the change in the inflation rate between February 2017 and March 2017 came from food and non-alcoholic beverages (contributing 0.09%), alcohol and tobacco (contributing 0.07%), clothing and footwear (contributing 0.06%) and miscellaneous goods and services (contributing 0.05%).

"The upward effect from food prices reflects a positive base effect (with food prices falling between the same two months one year ago), rising global food prices and the depreciation of Sterling," says Daniel Vernazza, Lead UK Economist with UniCredit Research in London.

In contrast, the upward effect from alcohol and tobacco “may have been influenced by the timing of price collection in relation to the introduction of duty changes”, say the ONS, which means the effect should reverse next month.

The upward effect from miscellaneous goods largely was due to price rises of jewellery, clocks and watches, again likely due to the depreciation of Sterling.

The upward contributions were broadly offset by a large downward contribution from transport prices (contributing -0.26%), primarily due to air fares and motor fuel prices.

The fall in air fares this year was related to the later timing of Easter, while the fall in motor fuel prices reflected falls in oil prices in March as well as a negative base effect.

"We expect inflation to rise in April and to reach 2.7% by the end of this year, largely due to the past depreciation of Sterling," says Vernazza.