Capital Properties FX
Capital Properties FX

Takeaways After BOE Inflation Report

“If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.” – Francis Bacon

BOE inflation report dominated news last week. Ever since the British decided that the best course forward is leaving the European Union there’s been a lot of uncertainty surrounding the future of the UK’s economy. So far nothing dramatic happened and things seem to be moving in the right direction. However, the Bank of England worries.

Mark Carney downplayed the recent progress we’ve seen in the UK’s economy and warned that the living standards will fall. The Bank’s opinion is that the effects of the Brexit vote are still to come and currently they are working their way through the economy. Two of the main problem areas are higher inflation and stagnation in wage growth.

The investors were slightly disappointed as they expected a bit more hawkish tone from the Bank of England. Instead, they got a relatively dovish press conference were Carney focused on the weakness in household spending and GDP. According to the BOE inflation report, the members of the MPC see the recent increase in inflation as a side effect of weaker British Pound.

Read Also: Is the FED Rate Increase in Cards After Last Week’s NFP?

BOE Inflation Report: Price Pressure Continues

In general, the British pound has been losing value ever since the outcome of the referendum. On the 23rd of June, at its highest point, GBPUSD traded above 1.50. Most likely, we are not going to see that kind of figures anytime soon. The chances that the pound has bottomed are far-fetched. The real obstacles and real issues are still to come. First of all, UK needs to unravel itself from the EU and that alone will take two years. In that time, anything may happen and as a result, the combined uncertainty should keep the British pound firmly under pressure.

BOE pointed out that the companies worry about the future costs and the access to the European market. As a result, wage growth has slowed down and soon we may see a spill over to hiring as well. The Brexit talks are going to be long and tough and currently, it’s extremely difficult to predict how it may affect the UK’s economy in the coming future.

The combination of higher prices and lower wage growth may have a significant impact on consumer spending. BOE inflation report revealed that the Bank sees the inflation rising to 2.7 percent in the second quarter. This means that the BOE may soon have to start thinking about higher rates. One of the members of MPC, Kristin Forbes again voted for an immediate rate increase to 0.50 percent to keep the inflation under control.

Exports and the Weak Pound – Key to UK Inflation Rate

The UK’s economy is highly dependent on consumer spending. In the opening months of this year, the Kingdom’s economy suffered a sharp slowdown. The rise in living costs took its toll on households and spending. In the first quarter, the GDP growth fell from 0.7 percent to 0.3 percent and many economists believe that the slowdown will continue as the inflation is rising.

The weaker pound has had a significant effect on the retail sector. Import prices are on the rise and retailers are already feeling the pain. Here, it’s wise to keep in mind that the UK is a service based economy. In fact, the services sector makes up about three-quarters of the entire United Kingdom’s economy. In the first quarter, economic activity in the given sector dropped from 0.8 to 0.3 percent.

However, there’s also an upside to a weaker British pound. The Bank of England seems to be confident that the slowdown in consumer spending will offset by an increase in exports. Rising business investment and improving trade performance should balance the overall situation as the overseas demand is on the rise. Clearly, that may change when the Brexit talks take off because right now we don’t know what the relationship between the EU and UK is going to look like after the divorce.

Final Word on Trading the Pound

In forex, news trading is always a gamble to a certain degree. After the release of the BOE inflation report, the traders sold pound aggressively but there was no follow through. During the New York forex market hours the GBPUSD started to recover but in the bigger picture, the pound should continue its fall.

As the inflation is on the rise in the UK, we should also be prepared for a surprise rate hike by the Bank of England. Even though, right now the probability of such a move is relatively low, we have to take into account the fact that the overall inflation level is well above 2 percent. Currently, the Bank tolerates it but it will not stay like this forever.

Read Also: Advance GDP and Fed Interest Rates

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