The Pound to US Dollar exchange rate (GBP/USD) softened by around -0.2 cents yesterday as markets reacted to the surprise drop in British inflation.
Disappointing forecasts for a reading of 1.7%, the UK consumer price index fell from 1.8% to 1.5% last month. Reduced transport fares and big discounts at supermarkets were the main drivers behind the drop-off in price pressures, which brought inflation down to its lowest level since 2009.
Sterling declined from 1.6980 to 1.6860 when the figure was released as some traders pared back their bets for an early interest rate hike from the Bank of England. However, demand for the Pound did not dip sharply because the majority of investors still anticipate that the bank will raise rates before the end of the year due to Governor Mark Carney’s hawkish policy statement last week.
Another factor that is working to support the Pound is the escalating conflict in Iraq, which is driving up oil prices as traders speculate over the possibility of a global oil shortage. This is likely to push up the consumer price index in subsequent months and could drive inflation towards the bank’s 2.0% target, which would make it easier for the BoE to start normalising monetary policy.
The US Dollar was treated to a mixed bag of data releases yesterday. On the one hand CPI rose unexpectedly from 2.0% to 2.1%, marking only the third time in six years that US inflation has outpaced its British equivalent. But on the other hand American building permits plummeted by -6.4% in a sign that not all sectors of the economy have recovered from the winter slowdown.
BoE Minutes
The Pound could come back into vogue this morning if the Bank of England’s latest minutes report strikes a hawkish tone, mirroring the Governor’s Mansion House speech last week, in which he intimated that rates could be raised by the end of the year. It is possible that some policymakers voted for a rate hike earlier this month and it is likely that Sterling will rally if this proves to be the case.
FOMC Decision
The Federal Reserve is set to cut its monthly asset purchasing target from $45 billion to $35 billion later this evening. The potential taper is largely priced into the US Dollar exchange rate and therefore is unlikely to a have a massive impact on GBP/USD trading but the accompanying press conference could prove more decisive.
With US inflation rising above the 2.0% target last month it is possible that Fed Chairwoman Janet Yellen could strike a hawkish tone and signal to markets that a normalisation of monetary policy is on the cards before the end of the year.
A hawkish BoE minutes report could drive GBP/USD back above 1.7000 but a hawkish FOMC statement could send Sterling down below 1.6900.
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