UK core CPI inflation set to remain sticky in June

United Kingdom’s CPI report will be published by the Office for National Statistics on Wednesday.
The annual UK headline and core inflation are expected to hold steady in June.
The UK CPI data could revive BoE August interest rate cut bets, rocking the Pound Sterling.

The high-impact Consumer Price Index (CPI) data for June from the United Kingdom (UK) will be published by the Office for National Statistics (ONS) on Wednesday at 06:00 GMT.

The UK CPI inflation report could reinforce expectations of an interest-rate cut by the Bank of England (BoE) in August, with volatility set to spike around the Pound Sterling.

What to expect from the next UK inflation report?

The UK Consumer Price Index is expected to rise at an annual rate of 2.0% in June, at the same pace as in May, sitting at the BoE’s 2.0% target.

Core CPI inflation is likely to stay unchanged at 3.5% YoY in June. Meanwhile, the British monthly CPI is seen rising 0.1% in the same period, compared with the previous increase of 0.3%.

Official data is expected to show that services inflation ticked down to 5.6% in June from 5.7% the month before, according to a Bloomberg survey of economists.

Previewing the UK inflation data, TD Securities (TDS) analysts noted: “Heavy deflation in the energy component should keep headline inflation close to the 2% target in June despite core likely remaining sticky at 3.5% YoY.”

“Focus will continue to be on services, and here we see an unchanged YoY reading as momentum remains strong. Taylor Swift should not have that big of an impact on this print - August is the bigger risk in our view,” the TDS analysts said.

The encouraging UK growth numbers and BoE Chief Economist Huw Pill’s prudent comments last week helped push back against the timing of the BoE’s first rate cut since the COVID pandemic hit the world in 2020.

Data released by the ONS last Thursday showed that the UK economy grew by 0.4% in May, above the expected 0.2% monthly expansion, after stagnating in April.

Meanwhile, BoE Chief Economist Pill dampened expectations of an August interest rate cut on Wednesday. Pill said, "I think it's still an open question on whether the timing for a rate cut is now," adding that services inflation and wage growth showed "uncomfortable strength" despite headline inflation falling to the BoE's 2% target in May.

Money markets currently price in a 50% chance of 25 basis points (bps) cut to the Bank Rate on August 1, down from 62% seen early last week.

How will the UK Consumer Price Index report affect GBP/USD?

Against this backdrop, the UK CPI data will be crucial to determining whether the August rate reduction remains on the table for the BoE. An upside surprise to the headline and core inflation data could support the recent dialing down of expectations of a rate cut next month, fuelling a fresh leg higher in the Pound Sterling. In such a case, GBP/USD could unleash the additional upside toward the 1.3100 level.

On the other hand, GBP/USD could retest the 1.2800 round figure if the UK CPI readings meet forecasts while the services inflation softens significantly. This could bring back bets for the BoE policy pivot in August.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the major and explains: “GBP/USD’s daily chart portrays overbought conditions, as 14-day Relative Strength Index (RSI) holds near 75, signaling risks of a Pound Sterling correction in the near term.”

Dhwani adds: “The pair needs to find acceptance above the 1.3000 psychological level on a daily closing basis to extend the upside toward the July 19, 2023, high of 1.3045. On the flip side, the immediate support is placed at the March 8 high of 1.2894, below which the 1.2800 resistance-turned-support could be tested. The last line of defense for buyers is seen at the 21-day Simple Moving Average (SMA) at 1.2748.” Dhwani adds.

Economic Indicator

Core Consumer Price Index (YoY)

The United Kingdom (UK) Core Consumer Price Index (CPI), released by the Office for National Statistics on a monthly basis, is a measure of consumer price inflation – the rate at which the prices of goods and services bought by households rise or fall – produced to international standards. The YoY reading compares prices in the reference month to a year earlier. Core CPI excludes the volatile components of food, energy, alcohol and tobacco. The Core CPI is a key indicator to measure inflation and changes in purchasing trends. Generally, a high reading is seen as bullish for the Pound Sterling (GBP), while a low reading is seen as bearish.

Why it matters to traders?

The Bank of England is tasked with keeping inflation, as measured by the headline Consumer Price Index (CPI) at around 2%, giving the monthly release its importance. An increase in inflation implies a quicker and sooner increase of interest rates or the reduction of bond-buying by the BOE, which means squeezing the supply of pounds. Conversely, a drop in the pace of price rises indicates looser monetary policy. A higher-than-expected result tends to be GBP bullish.

UK gilt yields FAQs

What are UK Gilt Yields?

UK Gilt Yields measure the annual return an investor can expect from holding UK government bonds, or Gilts. Like other bonds, Gilts pay interest to holders at regular intervals, the ‘coupon’, followed by the full value of the bond at maturity. The coupon is fixed but the Yield varies as it takes into account changes in the bond's price. For example, a Gilt worth 100 Pounds Sterling might have a coupon of 5.0%. If the Gilt's price were to fall to 98 Pounds, the coupon would still be 5.0%, but the Gilt Yield would rise to 5.102% to reflect the decline in price.

What factors influence the level of Gilt Yields?

Many factors influence Gilt yields, but the main ones are interest rates, the strength of the British economy, the liquidity of the bond market and the value of the Pound Sterling. Rising inflation will generally weaken Gilt prices and lead to higher Gilt yields because Gilts are long-term investments susceptible to inflation, which erodes their value. Higher interest rates impact existing Gilt yields because newly-issued Gilts will carry a higher, more attractive coupon. Liquidity can be a risk when there is a lack of buyers or sellers due to panic or preference for riskier assets.

How do interest rates impact UK Gilt Yields?

Probably the most important factor influencing the level of Gilt yields is interest rates. These are set by the Bank of England (BoE) to ensure price stability. Higher interest rates will raise yields and lower the price of Gilts because new Gilts issued will bear a higher, more attractive coupon, reducing demand for older Gilts, which will see a corresponding decline in price.

How does inflation influence UK Gilt Yields?

Inflation is a key factor affecting Gilt yields as it impacts the value of the principal received by the holder at the end of the term, as well as the relative value of the repayments. Higher inflation deteriorates the value of Gilts over time, reflected in a higher yield (lower price). The opposite is true of lower inflation. In rare cases of deflation, a Gilt may rise in price – represented by a negative yield.

What is the relationship between Gilt Yields and the Pound Sterling?

Foreign holders of Gilts are exposed to exchange-rate risk since Gilts are denominated in Pound Sterling. If the currency strengthens investors will realize a higher return and vice versa if it weakens. In addition, Gilt yields are highly correlated to the Pound Sterling. This is because yields are a reflection of interest rates and interest rate expectations, a key driver of Pound Sterling. Higher interest rates, raise the coupon on newly-issued Gilts, attracting more global investors. Since they are priced in Pounds, this increases demand for Pound Sterling.

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