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UK inflation set to shift focus to Bank of England rate cut timings

It was another poor day for European markets yesterday, with the return of US markets unable to lift the mood, as they too finished lower, due to a continuation of the hawkish rhetoric employed by central bankers this week as they pushed back on rate cut expectations which in turn helped to push yields as well as the US dollar sharply higher.

The weak finish in the US looks set to see European markets open lower in the wake of a softer Asia session after China Q4 GDP came in slightly short of expectations at 1%. The other metrics for industrial production were slightly better for December, rising 6.8% while retail sales slowed from 10.1% to 7.4%, falling short of forecasts of 8%.

The last few days have seen several ECB policymakers pour cold water on the idea of early rate cuts even in the face of a European economy that is on its knees. Even the head of the German Bundesbank, Joachim Nagel was in no mood to compromise despite a German economy that contracted by -0.3% last year and is predicted to struggle again this year.

With the Federal Reserve set to meet in 2 weeks’ time there was some hope that Fed Governor Christopher Waller would echo the tone of Powell’s post December meeting press conference in talking up the idea of US rate cuts.

This had all the hallmarks of being a triumph of hope over expectation and so it proved with Waller pushing back on market pricing of 6 rate cuts this year, as if he was going to do anything else with the Fed dots showing 3 rate cuts.

His comments that rate cuts ought to be done methodically and carefully, and in a calibrated fashion, spoke to a central bank that is no rush, and that rapid cuts are not necessary. This approach tends to push back on the idea of a March cut, and that the central bank will be very much data dependant.

The fact is that whatever the market may like to think about a Fed cut in March, the pricing risk is very much to the downside, and them not cutting, which suggests the risk of a further squeeze higher in yields. 

This caution from the likes of the ECB as well as the Fed this week is likely to be echoed by the Bank of England when it looks at this week’s economic data, after the latest UK wages data slowed to 6.6% in November.

While this was in line with forecasts there were some who suggested it supported the idea of an early rate cut. This seems unlikely with today’s December inflation numbers unlikely to show a significant enough slowdown to support the idea of a rate cut much before the end of Q2, although that’s unlikely to stop markets trying to go down that rabbit hole.

It is true that headline inflation in the UK has more than halved since March last year slowing from 10.1%, with November slowing more than expected to 3.9%, prompting speculation that the Bank of England might be closer to cutting rates in 2024 than had been originally priced.

While a further slowdown in inflation is to be welcomed and today, we can expect to see 3.8% for December, most of it has been driven by the falls in petrol prices over the past few weeks. Inflation elsewhere in the UK economy is still much higher although even in these areas it has been slowing.

Food price inflation for example is still much higher, slowing to 6.6% in December, while wages as we saw yesterday are still over 3 times the Bank of England inflation target.

Services inflation is also higher at 6.3%, and expected to slow to 6.1% in December, while core prices rose at 5.1% in the 3-months to November and may slow to 4.9% today.

It’s also worth keeping an eye on PPI as we could see a modest pickup in today’s numbers.

While the economic data this week is likely to be a key bellwether for the timing of when the Bank of England might look at starting to reduce the base rate, the key test for markets won’t be on whether we see a further slowdown in inflation at the end of last year, but how much of a rebound we see in the January numbers.

Whatever markets might look to price as far as rate cuts are concerned the fact that wages are still trending above 6% is likely to stay the Bank of England’s hand when it comes to looking at rate cuts when they meet in just over a fortnight.

It’s also important to remember that at the last rate meeting 3 members voted for a further 25bps rate hike.

While a further slowdown in the headline rate is likely to prompt a change of heart when it comes to calling for a rate hike, it will take more than a further slowdown in the headline rate for these 3 MPC members to do a complete 180 about turn and push for a rate cut.     

EUR/USD – currently looking soft with the failure to move through 1.1000 risking the prospect of a move back to the 200-day SMA at 1.0830. This is the next key support with a break of 1.0800 targeting 1.0720. The main resistance remains at 1.1000. 

GBP/USD – needs to get above the highs last week at 1.2800 to maintain upside momentum. Currently looking soft with the main support at 1.2590/1.2600, and below that at the 200-day SMA at 1.2540. We need to hold above here to keep upside momentum intact or risk a slide to 1.2250.

EUR/GBP – currently holding above trend line support just above the 0.8570/80 area, while we have resistance at the 0.8620/25 area last week. Need to see break either side to signal the next move, with further resistance at 0.8670 and the main support at the December lows at 0.8545.

USD/JPY – pushed above the 50-day SMA and the highs last week at 146.40 and looks set for a move towards 148.50. Support now comes in at the 146.30/40 area.


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