UK Inflation data removes some of the pressure from the BOE

UK consumer prices have become one of the key data releases since the Bank of England made inflation one of the knock outs that could cause the BOE to abandon its pledge to keep interest rates low. The August data, which saw headline inflation fall to 2.7% from 2.8% last month, in line with expectations, may have helped the BOE maintain the status quo, at least for now.

The largest contributors to the decline in inflation were motor fuels, air transport and clothing, as autumn fashions lines saw lower price rises this year compared with 2012. The biggest upward impact on prices according to the ONS came from furniture prices, along with household appliances. It’s no surprise that goods related to the housing sector have been rising, after all much has been made of booming house prices in the UK. The latest house price data from the ONS shows a 3.3% annual increase in the price of a UK home, in July up from 3.1% in June. Price gains are back at the highest level since Dec 2012, close to 3-year highs, adding to evidence that the housing market is helping to fuel the UK economic recovery.

So what does this mean for the BOE?

The Bank has found it difficult to communicate its forward guidance policy. The pledge to keep interest rates low for the long-term is full of caveats that make it hard to understand. The BOE is finding out that forward guidance only seems to work if it is firm, the BOE’s forward guidance may not be firm because there are too many caveats that could knock the BOE’s pledge out of action. However, receding inflation, even at quite a slow pace, gives the BOE some breathing space and could keep the market off its back, at least for the short term. Hence in the immediate aftermath of the inflation data Gilt yields are lower and GBPUSD backed away from the highs so far this morning and is finding some support at 1.5900.

However, even at 2.7%, inflation is still well above the 2% target, and at this pace it will take more than the 6 months the Bank has mentioned to bring prices back to the BOE’s target rate. Thus, the downside in Gilt yields could be limited, which may limit GBP weakness as we lead up to the release of GBP minutes on Wednesday.

We also have to remember the Fed meeting tomorrow. According to the Wall Street Journal’s Fed watcher Jon Hilsenrath, tapering will be a close call at the Fed meeting that starts today. Added to that, even if the Fed does start to taper its $85bn of monthly asset purchases, it could try and temper any hawkish impact by stressing its pledge to keep rates low for the long term. But, like the BOE, the market will be the one to decide if the Fed’s own version of forward guidance is credible or whether it’s worth challenging.

Thus, GBPUSD could be range bound in the lead up to the Fed decision, which is scheduled to be released at 1900 BST/ 1400 ET on Wednesday. Some key levels in GBPUSD to look out for:

Support:

1.5915 – daily pivot.
1.5890 – low from earlier today.
1.5840 – base of monthly Ichimoku cloud.

Resistance:

1.5940 – high form Tuesday (so far).
1.5965 – high from Monday and highest level for 9 months.
1.60 – key psychological level.

Source: Forex.com

17.09.2013