Thursday 18 January 2018

Daily Market Update: UK inflation ticks up marginally, but sterling back on the back foot

Chris Radburn/PA Wire
Chris Radburn/PA Wire

Simon Barry

Yesterday’s UK inflation data were broadly in line with City forecasts.

Headline CPI inflation picked up from 0.2% to a 12‐month high of 0.3% y/y in January mainly due to base effects linked to rapid declines in energy prices at the beginning of last year. Core inflation was slightly lower than anticipated in edging back to its November rate of 1.2% y/y having accelerated to 1.4% in December. Overall, there was little in these latest price data to stir up the UK rate debate with UK markets more focussed at present on Brexit risks ahead of this week’s crucial EU leaders’ summit which kicks off in Brussels tomorrow.

In particular, sterling’s price action on the foreign exchanges continues to display high levels of volatility. From as close to 79p at one point last week, Eur/Stg got to sub 77p briefly yesterday morning, but has since been sliding out once again, trading at around 78.25p this morning. The pound has also lost more than 1% against the dollar to open at around $1.4270, not helped by the results of a survey of British businesses indicating some loss of support for remaining in the EU (though the number of respondents in favour of staying in is still double those who support an exit).

We think it more likely than not that EU leaders will come to a deal this week, in which case there could be some short term relief for sterling on the exchanges. However, market Brexit jitters are not likely to disappear anytime soon, not least because the UK political debate, which will likely shift gears once the PM brings a deal home from Brussels, has the potential to be very divisive amid high levels of uncertainty about the referendum outcome. Thus, notwithstanding what we still consider to be a broadly constructive story on the UK macroeconomy, this political backdrop implies the need for those with sterling exposures to be mindful of associated downside risks for the UK currency in the period ahead.

In the Eurozone, the German ZEW was a bit of a mixed bag. The expectations component fell but not as much as had been expected, while the current situation element dropped by more than anticipated though it still remains above its long‐run average. On ECB policy, Austrian central bank governor Mr Nowotny said that turbulence in financial markets in recent weeks has been largely driven by emerging markets. He also expressed concern that market expectations ahead of March 10 ECB meeting could become as excessive as in December when expectations had “lost touch with reality”

In the US, The New York Empire Manufacturing survey showed a modicum of improvement in February, advancing from ‐19.4 to ‐16.7, but remained sluggish below both expectations (‐10.0) and the long run average (10.4). While we won’t be getting overexcited by a survey that only covers manufacturing (itself a distance second to the services sector in importance) in the state of New York, as a timely indicator it suggests that low energy prices and subdued global trade patterns continue to weigh on US manufacturing in February. Boston Fed President Eric Rosengren (who is a voter this year) said turmoil in financial markets and weak global growth could slow progress toward the Fed’s policy goals and may delay the need for additional interest‐rate increases. What’s interesting about Rosengren’s comments is that he is regarded as one of the most dovish officials at the Fed, and yet he’s couching his view in terms of a slower pace of hikes, not any cut in rates (despite the growing calls for outright policy easing in some quarters).

Looking to the day ahead, the monthly UK labour market report is published. Jobs gains have been ticking along nicely and are expected to advance a further 225k 3m/3m in December following 267k in November. Expectations are for the 3 month average unemployment to fall from 5.1% to 5.0% in December (which would represent a 12 month cumulative decline of 0.7 percentage points). Despite these encouraging employment trends, weekly earnings growth (an important measure of domestic cost pressure) has been slipping over the last couple of months and expectations are for 3 month average weekly earnings to slip to 1.9% y/y in December following 2.0% in November and 3 month average weekly earnings (ex. bonuses) to dip to 1.8% y/y after 1.9% in November. Bank of England Governor Mark Carney (along with other members of the MPC) has expressed a need to see a sustained rebound in earnings trends (amongst other things) before considering an increase in interest rates.

The minutes of the Federal Reserve's January meeting are published in the US. Although Fed Chair Yellen’s semi‐ annual report last week provided a comprehensive overview on the Fed’s outlook for the US economy (that postdates the January meeting), investors will be looking for some further insight surrounding the flavour of the FOMC's discussion regarding recent financial market turmoil and its potential impact on the US economy and future monetary policy. Housing starts are expected to advance 2.0% m/m in January following a drop of 2.5% in December, while building permits are expected to edge down 0.3% m/m (which would still give the 5th highest reading in level terms since the financial crisis) following a decline of 6.1%. Manufacturing production is expected to advance 0.2% m/m in January following ‐0.1%. 2016 Fed voter Bullard will give a speech on the US economic outlook and monetary policy and there will be some interest regarding how he characterises the recent downward pressure on both market and survey based measures of inflation expectations.

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