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UK inflation in focus as sterling hits post-Brexit high against the US dollar

European markets underwent a quiet and negative start to the new trading week in the absence of US markets yesterday, with most of the focus on the US dolla,r which has continued to drift lower, hitting its lowest levels in three years, after four successive weeks of declines.

The euro on the other hand has gone on a bit of a tear in the last couple of days, hitting a three-year high, helped in part by reported hawkish comments from a senior ECB official Ardo Hansson who suggested that the bond buying programme could stop completely in September this year if the data warranted. These changing expectations around the pace of stimulus withdrawal could well prove to be a headache for the ECB, given that the rise in the euro is likely to bear down on an already subdued headline inflation rate. The euro is already acting as a bit of a brake on the German DAX which has as yet been unable to get back to the highs it saw in November last year.

The pound has also benefitted from the bearish sentiment surrounding the US dollar, hitting its highest level since the day after the Brexit vote above 1.3800, with the prospect that we could well see a test of 1.4000 in the coming days.

Rising estimates of UK growth forecasts as well as a gradual rise in optimism that a “no deal” Brexit can be avoided has served to bolster the pound in recent days, however the sentiment remains at the mercy of the ebb and flow of political winds blowing between London and Brussels. This in itself is likely to make any move higher a distinctly choppy affair.

Last month the Bank of England governor found himself having to pen a letter to the Chancellor of the Exchequer explaining the reasons as to why the Bank of England had exceeded its headline inflation target by more than 1%, after CPI came in at 3.1% for November, the highest level since March 2012. Later this morning we’ll find out if the December numbers have fallen back from those heady peaks.

While most expectations are for that indeed to be the case, with a drop back to 3%, one can’t help feeling that this optimism might well be misplaced. Airfares were a key component that underpinned the CPI number in November and it is quite likely that could happen again, furthermore fuel prices also rose in December. The one bright spot could well be food and drink with shop price inflation expected to be on the soft side. Core CPI is expected to slip back a touch to 2.6% from 2.7%.

It seems more probable that inflation is likely to remain stickier than usual for the next couple of months as the January effect of higher rail fares also bleeds through into the numbers. It should then start to soften towards the end of Q1 assuming the pound stays at its current levels.

Retail prices are expected to remain steady at 3.9%, while factory gate prices are also expected to soften a touch from 7.3% to 5.3%.

US investors will also return from their long weekend with the latest Empire manufacturing survey for January which might well have weakened as a result of the recent bitterly cold weather on the Eastern seaboard.

EUR/USD – the euro continues to push higher, coming within touching distance of the 1.2300 level, with the potential to head towards the 1.2600 area and 61.8% retracement level of the 1.3995/1.0340 down move. Support should come in at 1.2170 the 50% level and the previous peaks at 1.2090.

GBP/USD – has run into some resistance just below the 1.3830 area which is currently capping the current rally. A move through here has the potential to test the 1.3980 area which is a 38.2% retracement of the 1.7190/1.1950 down move. Support comes in at the 1.3650 area and 1.3500.

EUR/GBP – currently being capped by the 100 day MA at 0.8910 and needs to close above that to open up the 0.9000 area. While below last week’s highs the risk remains for a return to last week’s lows at 0.8805/10 and a return to the recent range lows at the 0.8740 area, with a close below targeting a move towards 0.8650.

USD/JPY – has moved below the November lows and could well head back towards the 109.70 area, with support also at the 110.10 level. We currently have resistance at the 111.50 area as well as the 112.00 level.

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