Repricing the Pound: UK Inflation Slows, Bank of England Tightening Expectations Adjusted

FX Daily: The pound's big repricing is finally happening

UK inflation slowed more than expected in June, triggering a large dovish repricing in Bank of England tightening expectations and hitting the overbought pound. We now think a 25bp hike looks more likely than a 50bp move in August. GBP may stay under pressure, especially against the dollar – which we still expect to recover some ground into the FOMC meeting.

 

 

USD: Slowly regaining ground?

The round of US data releases was quite mixed yesterday, and as discussed by our US economist in this note, likely supported the case for a pause after a July hike by the Federal Reserve. June’s headline retail sales came in a bit softer than expected (0.2% month-on-month) but the control group which excludes some volatile components actually beat consensus (0.6% MoM). The real data miss came on the industrial production side, which confirmed the negative indications of a contracting ISM index and fell 0.5% MoM in June, despite expectations of 0% growth.

All in all, markets aren’t lacking evidence of slowing activity in the US, and the addition of the favourable disinflationary backdrop now weakens the case for another hike beyond July. The lagging unemployment remains the last piece of the puzzle to smoothen the transition to a more dovish rhetoric, and one that may keep the Fed leaning on the hawkish side by keeping all options open in July. From an FX perspective, next week’s FOMC meeting could be the opportunity to recover some lost ground. We cannot exclude the possibility that markets will position ahead of the meeting by closing some freshly-built speculative dollar shorts, which could help close the short-term USD undervaluation gap against the euro. Today, some housing data and MBA mortgage applications will be in focus and we still see room for some marginal dollar recovery.

One pair that remains overvalued despite recent USD-negative swings is USD/JPY, and we have been observing fresh weakness in the yen during the late US session and throughout the Asian session following dovish comments by Bank of Japan Governor Kazuo Ueda. With a little over a week to go before the BoJ rate announcement, Ueda said it would take a shift in the assessment to achieve its inflation targets in order to change the ultra-accommodative monetary policy stance. We should note that these remarks by Ueda are quite in line with his recent efforts to carefully manage expectations on the dovish side. We don’t necessarily see indications that would significantly lower the chances of a policy shift in July. As noted by Ueda in recent comments, the new projections will remain the key factor next week. Market reaction has likely been heightened by the proximity to the meeting.

Not too far from Japan (relatively speaking), New Zealand saw the release of second-quarter inflation overnight. Headline CPI slowed from 6.7% to 6.0% year-on-year, slightly above the 5.9% consensus but still below the bank’s 6.1% forecast. One important caveat: non-tradeable inflation (watched closely by the Reserve Bank of New Zealand) slowed less than the bank’s forecasts, and the RBNZ-issued core inflation gauge remained unchanged from the first to second quarter at 5.8% YoY. Markets now price in 50-60% chance of a hike by November, which looks about right in our view, even though NZD’s near-term outlook remains much more driven by external factors.