Pound-to-Dollar Rate Assails 1.30 as Greenback Slumps in Response to August Inflation Disappointment

-USD seen bathed in red afer inflation data surprises on downside.

-CPI falls to 2.7% for August, with core CPI dropping to 2.2%.

-Comes amid trade war detente that analysts are now playing down.

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The Dollar handed back gains and was seen swathed in red Thursday after inflation surprised on the downside for August, reinforcing an earlier downward bias arising from signs of a fresh detente in the U.S. "trade war" with China.

U.S. inflation rose by 0.2% during August, unchanged from back in July, when markets had looked for a 0.3% increase. This pushed the annualised rate from 2.9% back to 2.7% when markets were looking for a decline to only 2.8%.

Core inflation, which removes volatile commodity items from the goods basket and so is seen as more representative of domestically generated inflation pressures, rose by just 0.1% when economists had been looking for price growth of 0.2%. This knocked the annual number down from 2.4% to 2.2% when markets had looked for it to hold steady.

Thursday's data undermines the consensus that US inflation pressures are rising and may call into question expectations around Federal Reserve (Fed) interest rate policy. 

"Today's CPI figures echoed some of the softness seen in producer prices yesterday, with both headline and core measures coming in below consensus expectations," says Andrew Grantham, an economist at CIBC Capital Markets. "If core inflation doesn't pick up more meaningfully next year, that would result in an even more gradual pace of rate hikes. As such today's figures may be slightly negative for the US$ and see long-term yields fall a little."

Markets care about price and inflation data because it has direct implications for interest rates. Changes in interest rates, or hints of them being in the cards, are only made in response to changes in domestic inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"There is no reason to suspect that the weaker increase in consumer prices in August is the start of another dip like we saw in early 2017. With labour market conditions tight, wage growth accelerating and input prices being pushed up by capacity constraints and recently imposed tariffs, there is plenty of upward pressure on prices. The only disinflationary force is the dollar’s recent resurgence, which will put some downward pressure on imported goods prices. Overall, we expect core inflation to remain slightly above 2% in the second half of this year," says Paul Ashworth, chief U.S. economist at Capital Economics.

Above: Pound-to-Dollar rate shown at daily intervals.

The US Dollar index was quoted 0.01% lower at 94.79 following the release after whittling away an earlier 0.12% gain.

The Pound-to-Dollar rate, which has also been influenced by the Bank of England interest rate statement, was 0.25% higher at 1.3077.

The EUR/USD rate, which is also being impacted by the European Central Bank press conference that began at 13:30, was 0.30% higher at 1.1661.

Above: Euro-to-Dollar rate shown at daily intervals.

"The dip in the y/y core rate to 2.2% from 2.4% reinforces our view that the immediate inflation threat is limited, now that the run of increases due to adverse base effects from March through July is over. The Fed is raising rates because it fears that the falling unemployment rate threatens future inflation, not because it is scared of the immediate outlook. The August data, therefore, don’t materially change the outlook for the Fed meeting this month; they’ll hike, and leave in the Dec dot too," says Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics.

The Federal Reserve has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so that the top end of that range hits 3.25% around the end of 2019.

However, the late stage of the current economic cycle, the "trade war" and other events elsewhere have got analysts and economists increasingly attuned to the prospect of a shift in the Federal Reserve's thinking about the economic outlook.

Such a thing could eventually herald a slowdown in the pace at which the central bank raises interest rates and has been billed as a likely watershed moment for currency markets. But as could be seen Thursday, not all are buying this idea. 

"While today's data suggests that we are less likely to see core inflation hit 2.5% this autumn, we would not rule it out and still see upward risks to core inflation. Continued increases in wage costs and the effect of the Trump administration's tariffs are likely to put upward pressure on prices," says Jonas Goltermann, a developed market economist at ING Group.

Trade War Detente Played Down

August's data comes after the Wall Street Journal reported Wednesday that U.S. officials have sought fresh talks with Chinese counterparts over the tariff fight between the world's two largest economies.

This led to a brief moderation of unease about the so-called "trade war" and sent the safe-haven Dollar lower during that session. 

President Trump has announced the intention to impose tariffs on Chinese exports worth a total of $250 bn, although the levies on $200 bn of this number are yet to actually be introduced. Trump said at the weekend he is ready to move forward with those tariffs but that whether he does or not will depend on actions from the Chinese side.

"The $200 billion we’re talking about could take place very soon, depending on what happens with them. To a certain extent, it’s going to be up to China. But we’ve taxed them $50 billion — that’s on technology. Now, we’ve added another $200 billion. And I hate to say this, but, behind that, there’s another $267 billion ready to go on short notice, if I want. That totally changes the equation," Trump told reporters aboard Air Force One at the weekend.

The US alleges China uses "unfair" trading practices that, among other things, force American companies operating in the country to hand their intellectual property over to Chinese companies. Combating these practices was a key part of President Trump's electoral campaign offering and is among a range of issues that he has long spoken out against.

Fears the tariff fight will dent economic growth the world over have been growing within the analyst community in recent months. And some have been quick to play down the importance of Wednesday's report of fresh talks between the US and China.

"Another meeting alone does not signal a break through or change in position by either the US or China. Without immediate trade progress, there is still a high risk that President Trump will follow through on plans to impose tariffs on a further USD200 billion of imports from China. For high beta commodity related and emerging market currencies to stage a more sustainable rally, it will require more concrete evidence that trade tensions between the US and China are de-escalating," cautions Lee Hardman, a currency analyst at MUFG.  

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