UK inflation data dropped Wednesday morning and it was softer than expected. Pound moved lower on the news. Bank of England decision tomorrow is now looking pretty straightforward.
Inflation Came in Under Forecast
UK inflation held at 2.8% in May according to the Office for National Statistics. Economists had been expecting 3.0%. It matched April’s reading and came in below what most people on Wall Street and in the City were penciling in.
Lower than expected inflation is generally good news for an economy dealing with price pressures. But for the pound it created a small problem. If inflation is cooling faster than expected the Bank of England has less reason to raise rates. Less rate hike expectation means less reason to hold sterling. So the pound dipped.
Part of the softer reading connects to what has been happening with energy. Recent progress toward reopening the Strait of Hormuz has eased some of the fuel cost pressure that had been feeding into UK prices over recent months. That geopolitical development is starting to show up in the actual data now.
Pound Moved but Not by Much
GBPUSD dropped about 20 pips after the inflation print. Fell toward $1.34 before recovering some ground and trading back above $1.3415. Small move. Not a dramatic reaction but enough to show the market noticed.
Sterling has been trading in a tight range between $1.33 and $1.35 for most of recent weeks. This inflation number probably keeps it in that range a little longer. There is no obvious catalyst right now to push it decisively in either direction.
Traders are being cautious ahead of the Bank of England meeting Thursday. Big directional bets before a central bank decision are risky. Most people are waiting to see what the BoE actually says before committing.
Bank of England Decision Is Tomorrow
Inflation coming in at 2.8% against a 3.0% forecast makes Thursday’s Bank of England decision easier to call. Rates are expected to stay at 3.75%. No change.
That is already the market consensus but the softer inflation number cements it. When prices are behaving better than expected the urgency for another rate hike fades. Bank of England’s main job is to keep inflation near 2%. At 2.8% it is above target but moving in the right direction. Not exactly a crisis that demands immediate action.
Not everyone on the Monetary Policy Committee agrees though. Two members have signaled they might still vote for a rate increase at this meeting. That minority view will be worth watching. If more members start leaning that way in coming months the calculus changes. For now the majority is expected to hold.
The Problem Underneath the Headline
Headline inflation at 2.8% looks decent. But dig into the details and there are still pressure points.
Services inflation accelerated to 3.7% in May from 3.2% in April. Services inflation is considered a better measure of domestic price pressure because it is less affected by global energy swings. It moving higher while headline inflation holds steady is something policymakers will want to keep watching.
Economy is also slowing at the same time. UK GDP shrank 0.1% in April. That adds another layer of difficulty for the Bank of England. They cannot raise rates too aggressively into a weakening economy without risking making the slowdown worse.
So the situation is this. Headline inflation is cooling which is good. Services inflation is ticking up which is less good. Economy is losing momentum which limits how much tightening is possible. Bank of England has to balance all three at once.
Holding rates Thursday is the easy call. What comes after that is where it gets more complicated.