Pound Sterling strengthens on strong UK Retail Sales, soft US core PCE report

Pound Sterling strengthens as strong UK retail sales data has deepened persistent inflation fears.
Fears of a technical recession have escalated as UK Q3 GDP was downwardly revised to a 0.1% contraction.
BoE policymakers may continue to endorse higher interest rates.

The Pound Sterling (GBP) extends its recovery on Friday, supported by upbeat UK Retail Sales data for November. The Office for National Statistics (ONS) reported that households’ retail spending surprisingly remained positive compared with the previous year, while market participants projected a sharp decline. Strong Retail Sales were boosted by a 2.8% increase in non-food retail stores as major discounts were offered amid the Black Friday Sale.

The upbeat Retail Sales data for November is likely going to allow Bank of England (BoE) policymakers to stick to their restrictive monetary policy stance. The growth rate in wages is still significantly higher than required to bring down inflation to 2%, and this appears to be empowering households to spend heavily. This could dampen confidence in a clear downtrend in price pressures.

The sharp recovery in the Pound Sterling suggests investors have ignored the downbeat Q3 Gross Domestic Product (GDP) revision, which points to a 0.1% contraction. This has deepened fears of a technical recession in the UK economy as the BoE has projected a stagnant performance in the last quarter of 2023.

After the release of the economic data, Finance Minister Jeremy Hunt said that “The medium-term outlook for the UK economy is far more optimistic than these numbers suggest".

Daily digest market movers: Pound Sterling recovers as US Dollar hits by soft US core PCE report

The Pound Sterling picks strength after the release of the upbeat UK Retail Sales data for November.
Monthly Retail Sales grew at a stronger pace of 1.3% against the consensus of 0.4% and a stagnant performance in October. The annual consumer spending surprisingly rose by 0.1%, while investors forecasted a contraction of 1.3%.
Retail Sales excluding fuel rose by 1.3% against expectations of 0.4%. The increase in Retail Sales was due to strong demand at non-food retail stores.
Meanwhile, fresh official figures have indicated that the UK economy contracted by 0.1% in the July-September quarter. In preliminary estimates, a stagnant performance was projected. The mild contraction in Q3 could escalate fears of a recession in the UK economy.
In December’s monetary policy statement, BoE policymakers expected the UK economy to stagnate in the fourth quarter. If the UK contracts again in the last quarter of the year, it will be officially considered as a technical recession.
Meanwhile, higher interest rates and cost pressures have dampened confidence of British businesses towards the economic outlook.
The Lloyds Bank Business Barometer dropped to 35%, falling by seven percentage points. A deteriorating demand environment and higher wage growth have been consistently impacting the confidence of businesses in the economy.
Going forward, higher consumer spending momentum would allow Bank of England policymakers to maintain their restrictive stance on monetary policy.
The broader appeal for the Pound Sterling is already upbeat as BoE policymakers have not delivered any dialogue regarding the unwinding of restrictive policy stance.
BoE policymakers have been refraining from endorsing rate cuts in 2024 as inflation in the UK economy is highest in comparison with other Group of Seven countries.
The UK inflation data, released on Wednesday, dropped sharply. Investors hope that the central bank will discuss lowering borrowing rates sooner.
Market participants see the BoE policymakers starting to cut interest rates from March after a big blow to price pressures in November.
The overall market mood is upbeat as the US Dollar Index (DXY) has fallen further after the release of the United States core Personal Consumption Expenditure Price Index (PCE) data for November.
The annual core PCE price index has decelerated to 3.2% from consensus of 3.3% and 3.5% from October. On a monthly basis, the Federal Reserve’s (Fed) preferred inflation measure grew slightly by 0.1% vs. 0.2% anticipated by investors.

Technical Analysis: Pound Sterling aims stability above 1.2700

The Pound Sterling has recovered well from the crucial support of 1.2640 amid improved market sentiment. The GBP/USD pair could deliver a fresh rally after breaking above the round-level resistance of 1.2800.

On a daily timeframe, the 20-period Exponential Moving Average (EMA) has acted as a major support for Pound Sterling bulls. Fresh momentum on the upside would appear if the Relative Strength Index (RSI) (14) manages to climb above 60.00.

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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