First it was Europe that was mired in its coldest deflationary winter ever, then America promptly caught on. It was only a matter of time when cheap energy prices claimed its next victim - Britain. While we have spoken at world's end about how deflation and not inflation was going to be the macroeconomic trend of 2015, it still surprises us that conventional financial media outlets report what has long been occurring as "news".
However, why all these matter to us is because of the profound effects inflation, or the lack thereof, has on monetary policies. We noted a while back that central bank policies have probably never been more polarized since Lehman. On the on hand we are witness the most frenzied pace of monetary easing, while on the other the world's most potent institution, the Federal Reserve, has been contemplating a rate hike late in 2015.
All that financial verbiage has meant that we have witnessed mega trends in the world's largest market - the global Foreign Exchange markets. Participants in the $3.5trn a day market have thoroughly enjoyed these trends. While we will not opine on those trends and our views on them in this note, readers should understand that it is safer to expect a continuation of said trends than a reversal, volatility aside.
Sitting On The Fence
Unlike the Eurozone whose February CPI change settled at -0.3%, the UK saw no change in its price index from a year ago, missing estimates of a 0.1% rise and down from January's 0.3% change. The core figure (excluding food and energy) missed expectations of 1.3%, coming in at 1.2% from January's 1.4%. The market collectively expects deflation to officially strike in March. This comes on the heels of the BoE's Governor Mark Carney's comments about inflation dropping below zero in the next couple of months. Earlier in March, the Bank of England's MPC voted to keep interest rates at a record low of 0.5%, but foresaw a rate hike somewhere in 2016. The BoE is expected to trail the Fed in terms of monetary policy.
However, a few hours later across the Atlantic, the US economy surprised to the upside when its CPI also saw no change from a year ago; analysts had expected a -0.1% print. If March's inflation prints a positive number, that would negate January's -0.1% CPI change as an outlier. Core CPI (excluding food and energy) rose by 1.7% over the same period last year, above expectations of a 1.6% print and up from January's 1.6%. Note that even when low energy prices were factored out, the 1.7% core inflation is still shy of the Fed's mandated 2% target.
Bank of England Governor Mark Carney forecasts that the inflation rate will drop below zero in the coming months, though policy makers have said they’ll look through the slump as it’s driven by temporary factors, particularly cheaper oil. Weak price growth means there’s little pressure on the BOE to raise its key interest rate from a record-low 0.5 percent.
“The risks to our inflation calls are firmly on the downside, which raises the risk that the BOE delays rate hikes even further,” said Rob Wood, an economist at Berenberg Bank in London.
The pound remained lower against the dollar after the data was released and was trading at $1.4923 as of 10:45 a.m. London time. It weakened for a third day versus the euro to 73.58 pence per euro. Interest-rate forward contracts are all but ruling out an increase before the middle of next year.
Nevertheless, BOE Chief Economist Andy Haldane has warned of a risk that low price growth will persist and feed into wages, pointing to a key division on the Monetary Policy Committee as officials debate when to begin raising interest rates.
Core inflation slowed to 1.2 percent last month, the lowest since November and below the 1.3 percent forecast by economists. Separately, the ONS said U.K. house-price growth cooled to 8.4 percent in January -- the lowest since March -- from 9.8 percent in December. London home values increased an annual 13 percent.
Sterling Under Pressure
The market's reaction was characterized by several knee jerks but we ultimately saw the offer hit hard on sterling. The currency has fallen more than 120 pips for the day, something that was to be expected following an uglier than expected inflation report. The GBPUSD currency pair, often nicknamed "Cable" by currency traders, had been rising over the last 5 trading days following the FOMC event last Wednesday which saw broad weakness in the Dollar.
UK Gilts, the US Treasury equivalent, were bid on the shorter maturities as traders now expect the a rate hike to be shelved well into 2016, affirming initial sentiments that the BoE will not tighten monetary policy until 2016. England will have a General Election in about 5 weeks time, possibly serving as another impetus for volatility in Sterling. We personally feel that further weakness in the currency is warranted; the BoE will likely not enact new measures to shore up flagging economic activity but will remain accommodative throughout this year.