For the fourth consecutive month, inflation came in higher than expected staying at 8.7% year-on-year, and even more concerningly core inflation rose further to 7.1% from 6.8%. To no surprise money markets anted up interest rate expectations, suggesting a 50% chance of a 0.50% hike tomorrow and 6% interest rates being priced in by February 2024. Digging deeper though producer price inflation came in much lower than expected, suggesting that on the production level there are signs that inflation is slowing. GBP initially rose off the data but since has weakened. Why? One reason could be that lower producer price inflation, or perhaps concern now is about the damaging effect of the potential for higher interest rates on the economy.
ECB member Villeroy threw a curveball at the markets by putting more importance on the duration of keeping interest rates at current levels, versus hiking rates further. Perhaps we are nearing the end of the ECB’s rate hike cycle?
* Daily move - against G10 rates at 7:30am, 21.06.23
** Indicative rates - interbank rates at 7:30am, 21.06.23
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Price action says it all, and with GBP dropping following that higher inflation print it suggests that perhaps markets are near their peak in pricing the potential for higher interest rates. We wait to see how GBP performs over the rest of the day.
Focus for the rest of the day falls on Fed Powell's testimony before the House. Focus will be on the extent Powell pushes back on the prospect on future interest rate cuts, and pushing the mantra of higher for longer to finally defeat inflation. USDcould be supported on the back of this.
Inflation in the UK seems to be going nowhere following another surprise to the upside, and as a result more pressure is being piled onto the Bank of England. However inflation on the producer level has continued to decline, suggesting there is some deflationary pressures as well. Tomorrow’s base case remains for a 0.25% interest hike with a 50% chance of a 0.50% hike.
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