Pound to Dollar: Sticky UK Services Inflation Boosts Sterling Exchange Rates

April 18, 2024 - Written by John Cameron

STORY LINK Pound to Dollar: Sticky UK Services Inflation Boosts Sterling Exchange Rates

The Pound to Dollar (GBP/USD) exchange rate dipped further to 5-month lows just above 1.2400 on Tuesday before a recovery to 1.2470 after the latest UK data.

Expectations of near-term Federal Reserve interest rates have continued to fade with the potential for a June cut close to being ruled out while the chances of a July cut are now below 50%.

The latest UK inflation data, however, has also triggered fresh doubts over a near-term Bank of England rate cut which has helped underpin the Pound.

On Tuesday, Fed Chair Powell stated that there had been no further progress in lowering inflation this year and this is liable to delay rate cuts.

ING commented; “Both Chair Jay Powell and the often dovish-leaning Vice Chair Philip Jefferson acknowledged the slower progress on inflation and hinted at delays to cutting rates.”

It added; “The risks remain tilted to further dollar gains.”

Markets are also wary over risk conditions and Middle East tensions.

Jane Foley, senior forex strategist at Rabobank commented; "On any escalation of the Middle East crisis, we would expect the U.S. dollar to benefit from safe-haven flows."

These elements will make it difficult for GBP/USD to recover further with a move back above 1.25 essential to improving the outlook.

The headline March year-on-year inflation rate declined to 3.2% from 3.4%, but slightly above consensus forecasts of 3.1%.

This was still the lowest headline rate since September 2021.

There was a similar picture for the core inflation rate with the annual rate retreating to 4.2% from 4.5%. Although just above expectations of 4.1%, this was the lowest core reading since the end of 2021.

The largest downward contribution came from food prices which was partially offset by the increase in fuel prices.

Food inflation declined to 4.0% from 5.0% previously.

The inflation rate for goods declined further to 0.8% from 1.1% while the services-sector rate edged lower to 6.0% from 6.1%.

According to Yael Selfin, chief economist at KPMG UK, commented; “The overall outlook for inflation remains broadly positive, however there are several risks which could cause a setback.”

She pointed to the risk of higher oil prices and impact of a higher minimum range.

Selfin added; “Today’s data are unlikely to move the needle for the Bank of England. We expect inflation to return to target later this spring, which raises the prospect of interest rate cuts from June onwards.”

ING pointed to sticky inflation in the services sector and considers that next month’s data will be crucial given annual indexation of many prices in the services sector.

It added; “if we’re right that April’s data proves stickier than the Bank is expecting, then we think that would drastically reduce the chances of a cut in June, too. Our base case is that the Bank will cut rates for the first time in August.”

Tomasz Wieladek, chief European economist at asset manager T. Rowe Price was notably uneasy over the outlook and commented; “Together with the rising momentum in wage inflation, the sticky services inflation numbers raise the risk the UK inflation battle is far from over and perhaps not yet won.”

He added; “If services inflation and wages continue to remain persistently at these high levels, the risk the Bank of England will have to hike this year is rising.”

According to MUFG, data releases should make the BoE more cautious over beginning to cut rates until they have more confidence that persistent inflation risks continue to ease.

Nevertheless, it added; “The recent deterioration in UK labour market conditions could also play a role in putting more pressure on the BoE to cut begin cutting rates ahead of the Fed. In these circumstances, we expect the pound to weaken further against the US dollar in the near-term although it may eke out further modest gains against the euro.”

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TAGS: Pound Dollar Forecasts