Sterling rallies after UK inflation stays high – Will the pound gain strength this week?

The Pound rallied and saw some gains in the recent week finishing at 1.1423 against the Euro and 1.2392 against the Dollar. The pound strengthened after the UK labour market data on Tuesday displayed a new record high for UK wages showing the UK is nowhere near finished with high inflation thus putting pressure on the Bank of England (BoE) to raise the interest rate by 50 basis points.

This upswing in the Pound continued after Wednesday showing a smaller than expected decrease in inflation for the UK, the year-on-year Consumer Prices Index stood at 10.5% in December down from 10.7% in November. This small decrease in inflation was driven by falling fuel prices, however, there were upside pressures from restaurants, food, hotels and non-alcoholic beverages.

These circumstances led to the core CPI inflation reading year on year for December as 6.3%, a level unchanged from November. This core inflation is much higher than the Bank of England target 2.0% rate which may force the BoE to continue aggressively increasing interest rates, indicating a 50-basis point hike in February. This continuation of high inflationary pressure opens up the possibility of further interest rate hikes moving forward.

However, it’s not just the UK where an aggressive interest rate strategy appears to be set to continue. European Central Bank (ECB) president Christine Legarde has stayed steadfast in her hawkish stance on interest rates. Legarde commented on Thursday at a panel discussion during the World Economic Forum: “We shall stay the course until…we can return inflation we can return inflation to 2 per cent in a timely manner”. She also commented that financial markets should “revise their position” that the ECB would slow down its interest rate hikes in response to signs that inflation has peaked in the Eurozone.

In an interview on Sunday ECB board member Klaas Knot backed this aggressive approach stating, “Expect us to raise rates by 0.5% in February and March and expect us to not be done by then and that more steps will follow in May and June”.

The Federal Reserve (Fed) on the other hand is poised to slow the pace of their interest rate hikes for the second straight time in February, as economic data indicates US inflation is finally decelerating with inflation being announced at 6.5% this month, a 12-month low.

However due to the US labour market remaining very tight with unemployment at a 50-year low, questions remain over when the fed will stop increasing interest rates. On Thursday it was signalled that the Fed would continue to raise interest rates with Lael Brainard the vice-chair of the Fed signalling that the US has more to do to get inflation closer to its 2% target. She commented “Inflation is high, and it will take time and resolve to get it back down to 2 per cent. We are determined to stay the course”.

She further stated the fed will have “very, very extensive discussions” over the next interest rate rise on February the 1st which looks set to be either a 25 or 50 basis point rise. Most officials in the US have signalled their support for a shift down to a 25-basis point rise in contrast to expectations for a 50-basis point rise for the BoE and ECB.

In the week ahead data comes out for the US, Eurozone and US that gives indications on the strength of each economy. But the 1st and 2nd of February is where the focus is, not just for what the interest rate decisions of the three central banks will be, but also the tone and remarks of the Fed, BoE and ECB and whether each central banks aggressive interest rate strategies will continue and to what extent.

Will the Pound continue its gains against the Euro and the Dollar based on interest rate expectations? Or will the markets change their tact based on upcoming data and continuing remarks from members of the three central banks?

Key dates this week 

Thursday – Durable Goods Orders – Indicates the state of US production activity.
Thursday – Gross Domestic Product Annualized – indicates the pace at which the US economy is growing or contracting.
Thursday – Nondefense Capital goods orders ex Aircraft – indicates state of US production activity.

Tuesday – Services PMI – indication of the economic situation of the UK services sector. Any reading above 50 signals expansion and any reading below 50 signals contraction.

Monday – ECB president Legarde speech – Her comments can affect the strength of the Euro.
Tuesday – Global composite PMI – Indication of the Eurozone’s economic situation. Any reading above 50 signals an improvement on the previous month and any reading below 50 signals contraction.

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