UK inflation preview: CPI expected to fall, but the road back to target may take 6-months

The Pound comes back into focus this week, following on from a week that saw the Bank of England head up a raft of top tier announcements that also included jobs and PMI data. While the Federal Reserve may have taken on a notably dovish approach, the Bank of England remains cautious thanks to an elevated inflation standing. We can see the problem faced by the BoE below, with the November figure standing well above the likes of the eurozone and the US. This highlights exactly why markets are pricing in a delayed start to the monetary easing process compared with the ECB and Federal Reserve.

Looking at market expectations (via Eikon), we are currently seeking expectations for the Bank of England are a May rate cut, kicking off a total 100-basis points worth of easing over the course of 2024. Wednesday’s inflation report could move markets through adjustments in these expectations, with a push towards looser monetary policy bringing potential sterling weakness. Conversely, a strong inflation report could dent expectations of a May cut, lifting sterling as the expected interest rate differential widens with the likes of the US and eurozone.

In terms of expectations, we can see that markets are looking for a decline to 4.3% on the headline figure, thanks to a 0.1% figure for the month. Meanwhile, core inflation is similarly expected to fall 0.3% to 5.4%. That would necessitate a 0% reading for the month of November.

A deep dive into the headline inflation gauge shows the fact that we are seeing the 0.4% November figure drop out this month, and there will be some hope that we can see a sharp decline in November given the decline in energy prices seen in the eurozone figure for that same month (-0.5%). We didn’t see it so much for the US data, but there is likely to be some read across for the UK and eurozone given the similarities on gas pricing and reliance. Nonetheless, what we can see here is that only the five-month annualized figure falls below the 2% threshold, meaning that we are on track to break below target once the May figure is drops out (in June). However, the fact that it falls so heavily below that target does raise questions over whether the BoE may in fact opt to ease ahead of that release in anticipation of a sub-2% figure. The ability to keep posting month figures around the 0% to 0.2% range will be key to getting back on track to reach 2%.

In terms of core inflation, we are yet to get into a position where the 2% target falls into play. Annualising any combination of the recent monthly figures fail to provide a sub-2% outlook, with the figure currently on track to fall into 3.5% when the May inflation reading is reported. We need to start seeing monthly figure at or below 0.2% on a regular basis. Given the view that inflation will fail to return to target anytime soon, markets will likely remain cautious over the potential for a prolonged period of tight monetary policy as the BoE seeks to look through energy and food price volatility.

EURGBP technical analysis:

EURGBP has been on the rise after falling back down into trendline support last week, with the pound losing ground against the euro at the beginning of this week. This rebound looks to be gathering momentum, with traders likely to remain bullish until the UK inflation report on Wednesday. The current challenge of Thursday’s peak of 0.8634 brings a potential near-term upside break for the pair.

A weak inflation release could further this story, bringing forward rate cut expectations to the detriment of the pound. Conversely, a strong price would heighten the possibility of another move back down towards trendline support.