UK INFLATION HITS NEW 40-YEAR HIGH
UK headline inflation hit a new 40-year high in June, aggravating the cost-of-living crisis and increasing the pressure on the Bank of England (BoE) to deliver bigger interest-rate hikes over the coming months. GBP/USD has peeped over $1.20, but will it hold for long?To get more news about
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Yesterday, BoE Governor Andrew Bailey floated the possibility of a 50-basis point hike next month to try and battle inflation down to its 2% target rate. Money markets are now pricing an 85% chance of this happening and for the rates to reach 3% by year-end. Consumer prices rose 9.4% from a year earlier – the biggest rise since 1982 – and was fuelled mainly by surging energy prices, which threaten to exacerbate the problem when energy bills jump again in October. Despite the spike in UK interest rate expectations, the current difficult economic climate is similar to that of the early 1980s when inflation was at these same levels and the UK’s terms of trade shock relative to the US was as bad as it is now.
The US dollar remains on the backfoot this week, largely as a result of improved global risk sentiment evidenced by the rally in global stocks and commodity-linked currencies. Money markets are pricing in a lower probability of a larger 100-basis point US rate hike this month.
Stronger-than-expected results from US companies this week have helped boost risk appetite with the US benchmark S&P500 stock index rising 2.8% yesterday. Furthermore, narrowing yield differentials as a result of reduced US rate-hike bets due to peaking inflation indicators compared to increased rate-hike bets in the UK and Europe, have helped GBP/USD and EUR/USD extend around 2% higher this week. However, long-term chart formations point to another run at lower levels unless EUR/USD can climb back above $1.05 next month. GBP/USD is currently testing the top of its sharp 2022 downtrend channel – meaning this $1.20 battle could prove pivotal.
Further boosting risk sentiment and supporting the euro today is the news that Russia will reopen the Nord Stream 1 pipeline, which supplies more than a third of gas exports to the EU. The European Central Bank (ECB) meeting tomorrow and the Italian political risk are also key factors driving euro demand.
Due to inflation prints consistently surprising higher across Europe, money markets have raised the probability of a larger 50-basis point ECB rate hike tomorrow, which could send EUR/USD higher and weigh on GBP/EUR. However, the energy crisis likely trumps this supporting theme and although Nord Stream 1 is reopening, the EU is considering a voluntary 10-15% cut in natural gas use by member states once gas storage is sufficiently built up ahead of winter. There is still a risk that Russia will halt supplies in retaliation, which would exacerbate the energy crisis, increase Europe’s terms of trade shock and drag EUR/USD under parity.
