US Inflation Surprise Prompts GBPUSD Slump
The British pound and euro lost ground against the US dollar (USD) following the release of higher-than-expected inflation data.
The period of consolidation in euro and the recovery in pound sterling are now in doubt.
The move comes just a day after we reported mid-week that the US Federal Reserve would shift focus onto inflation when deciding when to raise interest rates.
We had warned that the shift of focus onto inflation, away from labour market data, was an attempt by the Fed to keep interest and exchange rates lower for longer - a clear negative for the USD in a currency market that is driven by central bank decision making.
Markets could be betting news that inflation is not falling as fast as expected could box the Fed into a summer rate hike - earlier than Yellen and co. would like.
"Despite Fed Chair Yellens best efforts this week to dampen down the markets enthusiasm around dropping “patience” and normalising rates policy, the market was having non of it. Most had inked into their minds a poor inflation print and wanted to resell rates and buy the USD at better levels," say Lloyds Bank in a note to clients.
Remember, the general rule for currencies at the present time is higher interest rates and interest rate expectations = higher currency conversion rates.
- At the time of writing the pound to dollar exchange rate (GBP-USD) is at 1.5442. As we can see this is back above the key support zone for the pair.
- The euro to dollar exchange rate (EUR-USD) is 0.21 pct higher at 1.1221. This is still a full 1.25 pct down on Wednesday's close.
- The US dollar to Canadian dollar (USD-CAD) is 0.23 pct lower at 1.2486.
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US Inflation Beats Expectations
The Consumer Price Index (CPI) Ex Food & Energy came in at 0.2%, analysts had forecast a reading of 0.1%.
Elsewhere, Year-on-Year data came in-line at -0.1%.
In the world of currency it is how data meets expectations that counts. When an upside surprise like this is announced markets have to re-adjust to the reality laid out by the data by buying USD.
That said, the outlook for US inflation remains undeniably soft.
Reacting to the data, Blerina Uruçi at Barclays says they are maintaining a view that declining energy prices will drive headline CPI down further in the near term, but its effect will be transitory and the pass-through to core CPI will likely be small.
“Given recent data and because of the strengthening of the dollar, we see downside risks to our baseline scenario from the core goods inflation component,” says Uruçi.
Dollar Rises, but Outlook Could See Further Declines
Commenting on the dollar’s reaction to the data Andy Scott at HiFX says:
“The U.S. dollar strengthened following the release of January’s consumer price inflation, despite it showing prices falling 0.1% compared to a year previous.
“The market was expecting the headline number to be negative due to the substantial drop in the price of oil that’s prompted a number of central banks to cut interest rates recently – some of them to a negative.”
HiFX remain sceptical that the Fed will raise rates in June as some have predicted and expect them to hold off until the back end of this year or even the beginning of 2016.
“We see this as weighing on the dollar which strengthened so much through the back end of last year and the beginning of this one, and sterling should benefit due to the strong economic landscape and the potential for a rate hike in the coming months,” says Scott.
Indeed, the outlook for the USD has deteriorated somewhat and technical indicators continue to advocate for further climbs.
We could be witnessing some overdue position squaring at the present time. The market had increasingly become long the pound sterling against the US dollar ensuring some re-balancing needed to happen.
Whether this is a temporary correction in the GBPUSD recovery, or a resumption of the longer-term downtrend, remains to be seen.
On the EURUSD pair we are not surprised that the gains by the dollar have been so strong.
The currency pair had been consolidating for some time and volatility had become unusually low.
We saw this as a sign that a big break - most likely to the downside - was due.