British pound pares gains on weaker than expected UK inflation data of 2.7%

The British pound sterling Tuesday weakened against a basket of world currencies, especially the U.S dollar, after the Office for National Statistics data showed UK inflation fell faster than was expected in February.

The bears exploited the fall in inflation to drag the pound, noticeably sensitive to monetary policy speculation, to 1.4037 against the dollar.

Sterling was quoted 0.10 percent higher at 1.4037 against the US dollar following the release Tuesday, after paring back an earlier 0.23 percent gain, while the Pound-to-Euro rate held steady with a 0.14 percent gain pushing it up to 1.1380.

The pound also eased back against the rest of the G10 basket. Notably, Sterling’s 0.65 percent gain over the Japanese Yen was cut in half to 0.30 percent, leaving the exchange rate trading at 149.23.

“From a technical perspective, the exchange rate of GBP/USD still remains at risk of sinking lower if bulls are unable to maintain control above the 1.4000 level. A breakdown and daily close below 1.4000 could invite a decline towards 1.3930 and 1.3850, respectively,” says Lukman Otunuga, research analyst at Lagos-based FXTM while commenting on the UK inflation figures.

Consumer price inflation eased to a 7-month low at 2.7 percent in February, down from 3 percent in January, as the impact of Sterling’s Brexit-fuelled selloff faded.

According to Otunuga, the weaker than expected inflation figures are unlikely to budge market expectations of the Bank of England raising UK interest rates in May.

He said if wage growth figures published on Wednesday print in line with forecasts at 2.6%, this could ease some pressure on the BoE to take further action beyond May.

“The Pound is suffering under the weight of a decline in inflation data & taming of Bank of England expectations for Thursday as a result,” says Neil Jones, an analyst at Mizuho Bank, referencing the importance of inflation to decision making at the Bank of England who will brief markets on their thinking on Thursday.

The UK Office for National Statistics data also indicated that core inflation fell further than was expected, dropping to 2.4 percent, down from the 2.7 percent seen in January and below the consensus forecast for a reading of 2.5 percent. The core inflation data removes volatile commodity goods like food and energy from the price basket, which is seen as a better representation of domestically generated inflation pressures.

A slower than expected rise in food and transport prices were the main drivers behind the move, although a fall in prices of fuel and accommodation services also played a role, according to the Office for National Statistics.

“CPI inflation is now at its lowest since July last year, with the latest dip being driven by lower fuel prices, as well as the continued fading of sterling’s post-referendum slide,” remarks Paul Hollingsworth, a senior UK economist at Capital Economics.

“The fallback in CPI inflation in February from 3 percent in January to 2.7 percent confirms that we have now reached a turning point, but doesn’t diminish the case for a near-term interest rate hike.”

Tuesday’s data is crucial for markets because it is the recent high levels of UK inflation that have spurred the Bank of England into action and led markets to expect another rate rise as soon as May. Interest rates are expected to become more of a driver for the pound now that Brexit headlines are likely to fade into the background following the March 19 deal on transition.

The BoE raised its interest rate for the first time in a decade back in November and warned in February of more to come if the inflation outlook evolves in line with its latest set of forecasts.

It projects the consumer price index will remain above the 2% target until at least the end of the first quarter 2021 however, Tuesday’s numbers appear to have called these forecasts into question somewhat, which poses questions about how agressive the BoE can be on rates.

On the other hand, the dollar was steady against a basket of major currencies ahead of the heavily anticipated Federal Reserve policy meeting under the new Fed Chairman, Jerome Powell.

With the central bank widely expected to raise interest rates in March, much focus will be directed towards the “dot plots” and Powell’s first press conference.

“Investors are likely to closely scrutinize the policy statement and conference for clues on whether the Fed will raise interest rates 3 or 4 times this year. King Dollar could be exposed to downside risks if Powell comes across less hawkish than market expectations,” says Otunuga, adding that though speculation of higher rates has the ability to support the Greenback, political uncertainty in Washington remains an invitation for bears to attack.

“Focusing on the technical picture, the Dollar Index is at risk of trading lower if prices are unable to keep above the 90.00 level. Repeated weakness below 90.00 could encourage a decline towards 89.50. If bulls are able to maintain control above 90.00, then the Dollar Index has scope to challenge 90.30 and 90.50, respectively.”