Inflation Surprise Puts a Floor Under Pound / Dollar Exchange Rate say Analysts

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Stronger than anticipated inflation figures out of the UK midweek will keep Pound Sterling bid against the Dollar, says a currency analyst.

Inflation for January read at 5.5% year-on-year said the ONS, a tick higher than December's 5.4% and the market's consensus expectation of 5.4%.

"Inflation figures for January in the UK are helping to consolidate gains in GBP/USD," says Francesco Pesole, FX Strategist at ING.

The month-on-month figure read at -0.1%, but this was less than the -0.2% the market was expecting.

Core inflation - arguably a more important metric for Bank of England policy makers - is running hot too, coming in at 4.4% year-on-year in January, ahead of the 4.3% expected by markets and December's 4.2%.

"A mild acceleration in both the headline rate (5.5%) and the core rate (4.4%) means that there is no apparent reason for markets to re-evaluate their aggressive bets on BoE tightening at the moment," says Pesole.

The market currently anticipates up to six hikes by year-end.

"This should continue to put a floor below GBP in the near term," says Pesole.

Above: Annual CPIH inflation rate highest since May 1992. CPIH, OOH component and CPI 12-month inflation rates for the last 10 years, UK, January 2012 to January 2022.

The Pound to Dollar exchange rate lifted to 1.3560 in the wake of the numbers, placing it in the middle of February's tight range, located between 1.35 and 1.36.

The lift in spot takes the lower end of the retail rate at around 1.3280 while more competitive retail rates for businesses and individuals can be found in a 1.3440 - 1.3490 bracket.

The ONS says the greatest upside contributions to inflation came from clothing and footwear, housing and household services, and furniture and household goods.

Large downward contributions to inflation came from from restaurants and hotels, and transport.

Inflation is nevertheless at a thirty year high and given the Bank of England has an explicit mandate to keep price rises at 2.0% markets are pricing in another interest rate rise at the March MPC meeting.

"The upside surprise is likely to add further pressure on the Bank of England to increase interest rates further," says Nikesh Sawjani, an economist at Lloyds Bank.

"The Bank of England has now gained a reputation for being a central bank that delivers and that provides rate support to the pound," says Marek Raczko, an analyst at Barclays.

• GBP/USD reference rates at publication:
  Spot: 1.3550
• High street bank rates (indicative band): 1.3180-1.3283
• Payment specialist rates (indicative band): 1.3440-1.3495
• Find out about specialist rates and service, here
• Set up an exchange rate alert, here

Following the inflation print beat, UK two-year bond yields have picked up marginally and are currently trading above 1.53%.

Rising bond yields - be they the two-year or ten-year tenor - are on balance supportive of the Pound.

"Risks to GBP seem skewed to the upside," says Raczko.

Expect yields to remain elevated as long as the market maintains a relatively aggressive expectation for future Bank of England rate hikes.

But were this market assumption to be challenged, i.e. by a signal that the Bank might ease off the pace, then bond yields and the Pound could come under pressure.

"On balance we expect the BoE to take a more cautious path, delaying the next hike until May and expect rates to reach 1.00% in August where we expect them to stay – far short of market expectations," says Modupe Adegembo, G7 Economist at AXA Investment Managers.

"While this is stronger than expected, we doubt this will have much implication for the financial markets today. It won’t change BoE expectations over coming meetings and hence GBP impact should also be minimal," says Derek Halpenny, Head of Research EMEA at MUFG.

The stronger than expected inflation data comes a day after the ONS revealed a strong outturn for the UK labour market, where the number of UK employees increased on the quarter to another record high.

The statistical agency's most timely estimate of payrolled employees showed another monthly increase (up 108,000) in January 2022 to a record 29.5 million.

The UK unemployment rate decreased by 0.2 percentage points on the quarter to 4.1%

The jobs market is anticipated to remain tight as the number of job vacancies in November 2021 to January 2022 rose to a new record of 1,298,400, although the rate of growth in vacancies continued to slow down.

Hot inflation readings combined with the tightening jobs market will offer some near-term support to the Pound at the very least.