Sterling plummets on strong US inflation and prospects for Fed rate cut in June

  • Sterling falls below 1.2600 following surprising and persistent US inflation data for March.
  • Monthly British GDP data for February will provide new clues about the performance of the economy.
  • The cost of living crisis in the UK supports the BoE's rate cut prospects.

The British Pound (GBP) weakens against the US Dollar in the early hours of the American session on Wednesday, as US Consumer Price Index (CPI) data for March remains stubbornly higher. Economists expected U.S. inflation to remain relatively high in March due to rising oil prices, insurance costs and rents. Strong price pressures would shift market expectations of Federal Reserve (Fed) rate cuts to the third quarter of this year.

Domestically, the British pound will be guided by the UK's monthly Gross Domestic Product (GDP) and factory data for February, which will be released on Friday.

The GDP data will offer a snapshot of the state of the economy. Factory data represents the country's manufacturing sector, a leading indicator of global demand. Weak figures would raise expectations of an early rate cut by the Bank of England (BoE), while better-than-expected data would indicate that the economy is returning to the path of recovery.

Daily summary of market movements: British pound weakens, US dollar rebounds

  • The British pound registers a vertical movement lower after facing selling pressure near the resistance of the round level of 1.2700. Surprising US consumer price inflation data for March has dampened the appeal of risk-sensitive assets.
  • Annual headline inflation grew strongly, at 3.5%, compared to the consensus of 3.4% and the previous reading of 3.2%. Core inflation, which eliminates the volatility of food and energy prices, rose 3.8% in the same period. Monthly, both the general and core CPI increased by 0.4%. Investors had expected them to have grown at a slower pace of 0.3%.
  • It will be increasingly difficult to convince those responsible at the Federal Reserve (Fed) that inflation is returning to the desired rate of 2%. For inflation to fall to the 2% target, the monthly CPI must increase at a constant rate of 0.17% throughout the year.
  • The US Dollar Index (DXY), which tracks the price of the Dollar against six major currencies, shoots up to 104.80 points.
  • In the UK, rising household living costs have prompted the Bank of England to call for rate cuts. The latest survey from the Financial Conduct Authority (FCA) showed that individuals' difficulties paying bills and credit fell annually in January. The agency estimated that 7.4 million individuals were facing problems meeting their monthly expenses, a figure lower than the 10.9 million registered in January 2023, but still significantly higher than the 5.8 million registered in February 2020.
  • Investors expect the BoE to pivot towards rate cuts after the June meeting. Speculation was fueled after Governor Andrew Bailey said market expectations of two or three rate cuts this year are “reasonable.”

Technical analysis: British pound falls vertically to 1.2600

Sterling weakens as US CPI data surprises. The GBP/USD pair crashes sharply after facing tough roadblocks near the round resistance level of 1.2700. The Pound offers a strong breakout of Tuesday's trading range, suggesting a bearish trend. GBP is likely to test the 200-day EMA near 1.2570.

On the downside, the psychological level of 1.2500, drawn from the December 8 low, will be important support for the Pound.

The 14-period Relative Strength Index (RSI) is oscillating within the range of 40.00-60.00, suggesting indecision among market participants.

Inflation FAQ

Inflation measures the rise in prices of a representative basket of goods and services. General inflation is usually expressed as a percentage of monthly and annual variation. Core inflation excludes more volatile items, such as food and fuel, which can fluctuate due to geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the target level of central banks, which are mandated to keep inflation at a manageable level, typically around 2%.

The Consumer Price Index (CPI) measures the variation in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage of monthly and annual variation. Core CPI is the target of central banks as it excludes food and fuel volatility. When the underlying CPI exceeds 2%, interest rates usually rise, and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually translates into a stronger currency. The opposite occurs when inflation falls.

Although it may seem counterintuitive, high inflation in a country drives up the value of its currency and vice versa in the case of lower inflation. This is because the central bank typically raises interest rates to combat higher inflation, attracting more inflows of global capital from investors looking for a lucrative place to park their money.

Gold was once the go-to asset for investors during times of high inflation because it preserved its value, and while investors often continue to purchase gold for its safe haven properties during times of extreme market turmoil, this is not the case. most of the time. This is because when inflation is high, central banks raise interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity cost of holding Gold versus an interest-bearing asset or placing money in a cash deposit account. Conversely, lower inflation tends to be positive for Gold as it lowers interest rates, making the shiny metal a more viable investment alternative.

Source: Fx Street

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