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UK Inflation is Skyrocketing, Sterling Falls Down

by Didimax Team

The pound sterling had strengthened against the euro and the US dollar after the release of UK inflation data yesterday. However, that currency immediately fell again in a short time. 

GBP/USD had already fallen to the 1.2360s range at the beginning of the New York session, while EUR/GBP shot up to above the 0.8700s level. UK inflation failed to weaken as expected and sparked concerns about its impact on the economy.

The United Kingdom Consumer Price Index (CPI) showed growth of 1.2% for month-over-month in April. Whereas, consensus only expected growth of 0.8%. 

The Core CPI inflation also accelerated with an actual increase of 1.3% versus expectations of 0.8% in the same period. Annual inflation data also missed expectations. 


BOE may Need to Raise the Rates

The annual inflation rate for all groups of goods and services was recorded at 8.7%. It was lower than 10.1% in the previous period, but higher than the consensus estimate pegged at 8.3%. 

Meanwhile, the Annual inflation for core goods increased rapidly from 6.2% to 6.8%. Following the release of UK inflation data, markets expect the BoE will need to raise interest rates again. 

It is especially in June by 25 bps, September by 25 bps, August (25 bps), and November (10 bps). The aim is to reach the terminal rate at 5.35%.

In fact, the market previously only calculated two more interest increases until the terminal of 4.85%. High CPI inflation data usually motivates central banks to raise interest rates.

Interest Rates Must Be Restrictive Enough

The condition above was positively impacting currency exchange rates. However, the relationship between these variables is fading for the pound sterling. 

The reason is that British economic conditions are threatened to decline sharply. It is especially if the Bank of England (BoE) really raises interest rates again to very high levels in order to suppress inflation. 

On the other hand, inflation risks getting out of control if interest rates are not restrictive enough. Simon Harvey as a head of FX analysis at Monex Europe stated his opinion. 

He said that market participants are now in a realm where if the BoE really meets market expectations and sets interest rates that high, they will be talking about deteriorating UK investment prospects.

It is also about the financial stability considerations that are starting to attract attention, so it is negative for UK assets.The GBP/USD duo is currently also pressured.

GBP/USD is Under Pressure

The GBP/USD is under a pressure by deteriorating global market sentiment amid uncertainty over US debt ceiling negotiations. Democratic and Republican representatives yesterday again ended negotiations with no sign of compromise.

This was triggering a risk-off of stock markets and high-risk assets to the U.S. dollar. Market participants are worried about the global impact that may arise due to the failure of US debt ceiling negotiations.

That is why; traders and investors are flocking to liquidate high-risk assets. This situation prompted the US dollar index (DXY) to continue its rally to the range of 103.90s in Wednesday's trading.

Democratic and Republican Ended Negotiations with no Compromise 

Democratic and Republican representatives yesterday again ended negotiations around the U.S. government's debt ceiling with no sign of compromise. Markets also do not expect a deal to be reached in the next few days.

A situation like this raising the risk of default in the superpower. In fact, default can plunge the US into recession and have a domino impact on the global economy

Moody's Analytics estimates that if the default lasts for less than a week, the American conomy will slump so rapidly that about 1.5 million jobs will disappear. 

If the default is prolonged until the summer, the unemployment rate could jump from the current 3.4% to 8% and the lending rate would skyrocket as well. 



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