Pound Sterling struggles between stubborn UK Inflation, robust US Retail Sales data

The Pound Sterling finds strong buying interest as the UK inflation came in higher than expected.
Higher fuel services prices boosted UK inflation.
The market mood remains downbeat as investors are less certain about Fed rate cuts.

The Pound Sterling (GBP) has surrendered some gains as the United States Retail Sales turned out significantly upbeat than expectations. The US Census Bureau has reported that consumer spending grew strongly by 0.6% against expectations of 0.4% and the former reading of 0.3%. Retail Sales excluding automobiles rose by 0.4% against expectations and the prior reading fo 0.2%.

Earlier, gains in the Cable were boosted by the release of the surprisingly stubborn United Kingdom consumer price inflation data for December. The GBP/USD pair recovers losses as hopes of an early rate cut by the Bank of England (BoE) have waned amid higher price pressures. The Consumer Price Index (CPI) came in higher than expected amid a significant rise in Oil prices and slightly higher service inflation.

Still-high inflation in the UK means that BoE policymakers have more room to maintain interest rates at the current 5.25% for a longer period. BoE policymakers have been warning that it is too early to discuss interest rate cuts as price pressures are far above the required rate of 2%.

Meanwhile, a sharp recovery in the Pound Sterling could stall as the market mood is quite cautious. Market sentiment has turned downbeat as investors are uncertain over when the Federal Reserve (Fed) will start the rate-cut campaign.

Daily digest market movers: Pound Sterling surrenders some gains as US Dollar advances

Pound Sterling delivers a V-shape recovery as UK inflation data for December has turned out stubbornly higher while investors anticipated it to remain soft.
The UK ONS has reported that monthly headline inflation grew at a stronger pace of 0.4% against expectations of 0.2%. In November, headline inflation contracted by 0.2%.
The annual headline inflation rose to 4.0% from 3.9% in November. Market participants anticipated a deceleration to 3.8%.
Core consumer price inflation, which excludes volatile food and energy prices, remained at 5.1% while investors projected it softening to 4.9%.
A sharp increase in price pressures suggests that taming the last leg of inflation is expected to be a challenge for Bank of England policymakers. This will offer a strong argument to BoE policymakers to maintain a restrictive monetary policy stance for a longer period.
Traders are expected to pare higher bets supporting an early rate cut from the BoE, which were boosted on Tuesday after a sharp decline in wage growth. The Pound Sterling witnessed a sharp sell-off in Tuesday’s session on slower wage growth and dismal market mood.
The market mood remains downbeat as traders pare bets in favour of rate cuts by the Federal Reserve from March after the hawkish commentary from Governor Christopher Waller.
Waller said the Fed should not rush to reduce interest rates until it gets confident that inflation will return to the 2% target sustainably.
The US Dollar Index (DXY) has printed a fresh monthly high above 103.50 as investors' confidence over a Fed rate cut in March is fading.
Going forward, the USD Index will be guided by the United States Retail Sales and the Industrial Production data for December. According to estimates, monthly Retail Sales are expected to grow 0.4% against 0.3% in November. Industrial Production is seen stagnant against 0.2% growth a month earlier.

Technical Analysis: Pound Sterling remains above 1.2600

Pound Sterling delivers a swift recovery after discovering strong buying interest near the round-level support of 1.2600. The GBP/USD pair has rebounded after testing the 50-day Exponential Moving Average (EMA), which trades around 1.2600. The near-term demand for the Cable will improve if it stabilizes above the 20-day EMA, which oscillates around 1.2690.

The GBP/USD pair manages to hold auction above the 50% Fibonacci retracement at 1.2590 (of the move from July 13's high at 1.3142 to October 4's low at 1.2037). The 14-period Relative Strength Index (RSI) oscillates in the 40-60 range, which indicates a listless performance.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.

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