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Rising Inflation in the United Kingdom

July 15, 2020 By Mircea Vasiu

The United Kingdom’s Consumer Price Index (CPI) was released today and it took the market by surprise. It exceeded expectations, as both the headline and the core data came out bigger than the forecast. 

What were the main drivers of higher inflation and what does it mean for the Bank of England?

Details of Today’s CPI in the United Kingdom

The CPI shows the change in the price of goods and services purchased by consumers and it is released monthly. However, the inflation level is adjusted to show the annual impact.

For the month of June 2020, the CPI came at 0.6%, rising from 0.5% a month earlier and above expectations of a decline to 0.4%. What is even more interesting is that the Core CPI (inflation that excludes the food, tobacco, energy, and alcohol prices, as they are considered too volatile and distort the data) increased to 1.4% from 1.2% previously. Obviously, there’s pressure on prices and the monetary policy will not hesitate to take decisions to fight it.

The GBP rose across the board on the news, with both the major GBPUSD and crosses (GBPCHF, GBPCAD) experiencing noticeable gains. This comes in sharp contrast with what Bank of England’s Tenreyro said earlier today – that the bank is actively discussing negative rates and that the Bank of England is currently conducting a review on the subject.

In other words, a hawkish CPI for GBP bulls that sends the pound higher across the FX dashboard, but also a dovish statement from the BOE. This is not something unusual in the currency market, when central bankers intervene verbally to steam the flows into, or out of, a currency. In fact, it is part of the way monetary policy is conducted, especially considering the principle of forward guidance that is a regular tool in all major central banks’ toolboxes.

Coming back to the actual CPI, the biggest increase in prices was noted on recreation and culture services, as well as games and clothing. The sharp increases exceeded the decline in food prices, causing the index to rise.

To sum up, currency traders use inflation data as a primary gauge to what the central bank will do next. Each central bank has its mandate focusing on price stability around the 2% level. If inflation falls below 2% and continues to fall, the central bank sends a dovish tone and expands the monetary policy – that is bearish for the currency. If, on the other hand, inflation picks up and investors see further upside potential, they bid for the currency, on expectations of a hawkish central bank future action.

That is why the GBP soared today. It remains to be seen if this is the beginning of a new trend or just a simple market reaction to unexpected inflation data.

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